Cost Is Entirely Subjective
Don't Confuse Cost with Price
Many people — including some professional economists — use the words “cost” and “price” interchangeably. For example, “how much did your cheeseburger cost,” to which the reply might be “$12.” But it is the “price” that is $12; the cost is unknown, unobservable, and unmeasurable, according to the widely understood meaning of the word “cost” in the lexicon of economics.
Definitions are in order. “Price” is dollars per unit for some good or service. It really is just that simple. For accountants, tallying up accounts for a business, cost is dollars expended by the business for some good or service. Fair enough. But for economists, cost is value forgone, and value is psychic satisfaction that occurs in an individual, unique mind. “Utility” is a synonym for “value” for most economists, but I prefer the word “value,” because it carries no necessary connotation of usefulness. Individuals frequently value things that are not useful.
The Subjective Theory of Value was adopted widely by professional economists, at least since the time of Carl Menger, William Stanley Jevons, and Léon Walras, who were late 19th Century economists. These three economists are often credited by economic historians as co-developers of the subjective theory of value. But Menger was the only one of the three who fully embraced and articulated the idea that value is entirely subjective, immeasurable, and rooted completely in individual mental phenomenon.
Menger’s insight was a radical departure from the Labor Theory of Value posited by classical economists like Adam Smith, David Ricardo, John Stuart Mill, and Karl Marx, which theory declared that the source of value for goods and services is due to the labor required to produce them. So far as I know, the Labor Theory of Value is thoroughly debunked and rejected by all but a vanishingly small handful of economists who are Marxist apologists.
The proposal that value is subjective is not at all startling to non-economists. The proposition seems quite obvious to most people, as evidenced by a multitude of aphorisms – one person’s treasure is another’s junk, beauty is in the eye of the beholder, etc. – but it took the science of economics more than 100 years to settle on the Subjective Theory of Value. Science is and should be slow going.
I invite readers who want a deeper dive into concepts about value to read my little book, Morality and Capitalism, which is available here for a quite low price. Or, for a zero price, but still some cost, since it will take time to read it, thereby generating an opportunity cost (as it’s called by economists), here’s an excerpt.
Price is objective. In everyday use, the word “objective” describes empirical phenomenon, phenomenon perceivable with human senses or perhaps instruments. Objective phenomena are free of human feelings, values, or opinions.
What people mean by the word “facts” are objective statements. That cat is furry; that ball is round; Paris is a city in France, x-rays are electromagnetic waves, and so on. For the most part, people do not disagree about things that are objective, but they sometimes do, due to misperception or mistakes. Optical illusions are examples of such.
Which horizontal line is longer? Answer: they are exacetly the same length.
Cost is subjective. In everyday use, the word “subjective” describes an individual’s feelings, preferences, tastes, values, or opinions. Individuals frequently disagree about subjective matters. They do so because
1. they are unaware of some true, objective facts,
2. they have different values,
3. they have similar values, but they weight them differently.
A super majority of professional economists accept the Subjective Theory of Value, but surprisingly enough, some economists resist and even deny the logical implications of the theory, even though they profess to accept it.
One important example is this: some professional economists argue that like price, cost can also be objective. Many economists speak and write as if cost were objective, even though they profess that value (a.k.a., utility) is subjective. In the balance of this essay, I want to show that since value is subjective, which it surely is, then cost must also be subjective. When? Always.
Some economists argue that markets translate value into the metric of dollars. Upon translation, the argument goes, we can compare costs to benefits, add up costs, declare one choice to be more or less efficient than another, and speak in concrete terms of social costs and benefits. The entire enterprise of CBA (cost benefit analysis) is predicated on this erroneous proposition.
Here is a summary of the erroneous argument that markets translate value, which is subjective, to a dollar measure, which is objective.
1. Cost tends to involve real, objective sacrifices.
2. Cost is fundamentally tied to WTP (willingness to pay) and WTA (willingness to accept).
3. WTP and WTA are observable, measurable, objective facts.
4. WTP and WTA can be added and compared numerically, which enables measurement of social cost and benefit.
Here is a summary of why the argument that cost can be objective is utterly erroneous.
1. “Things,” such as pieces of gold, cars, and houses, if forgone, are not sacrifices for an individual who confers no value on gold, cars, and houses. Since cost is value forgone, by definition, cost remains subjective, depending as it does on an individual human mind perceiving that some value has been forgone.
2. WTP and WTA are observable, measurable, objective facts, true enough. But what they measure are prices, not costs, by definition. Prices, under some highly limited conditions, are objective measurements of marginal value, for some individiual person. But it is obvious that market price is not a measure of marginal value for persons who
a. are not involved in the market in any way (e.g., bald people and the comb market),
b. are unable to pay because they have no money,
c. are involved in the market, but experience what economists call consumer surplus or producer surplus.
Consumer surplus is a dollar measure of value received by a buyer who would have been willing to pay a higher price than the price paid, but did not have to because the good was available for a single, lower price, which economists call the “market price.” Producer surplus is a dollar measure of value received by a seller who would have been willing to accept a lower price than the price received but did not have to because the good could be sold for a single higher price, which economists call the “market price.”
Market prices cannot and do not measure either consumer surplus or producer surplus. Even if demand and supply curves were real, instead of being only models, value cannot be translated magically into the metric of dollars, because value is psychic satisfaction that has no metric.
Hence, market prices cannot and do not translate consumer surplus or producer surplus to dollars. Hence, there is no possibility of measuring cost objectively, not for an individual, and most certainly not for a group of individuals. Hence, the notion of social cost and social benefit is conceivable, but unmeasurable, which renders the possibility of CBA impossible, even as an approximation.
Here is an example of what one highly competent, skilled, respected, and admired professional economist wrote recently. “The actual readiness to engage in payment or acceptance of a sum in exchange for a good or service is an objective phenomenon. It can be documented, measured, and aggregated. A person may say, “I would pay up to $100 for this new gadget.” That statement reflects a subjective preference, but the value in objective, monetary terms is $100 worth of goods or services to this person, despite the fact that utility is an underlying driver behind this valuation.”
The same professional economist went on to write, “Social cost, by extension, sums up the private costs across all individuals in society. It, too, is objective in the sense that if we could measure what everyone would pay (or must be paid) in dollar terms for a project to happen, that sum is the social value of the project. There is no inherent difference between costs and benefits as these can be viewed as two sides of the same coin, and they are both valued in terms of their opportunity cost to society. The fact that it is often difficult to measure these numbers does not mean that cost ceases to be objective. The challenge is methodological, not conceptual.”
The concepts of social cost (value forgone by society) and social benefits (value received by society) are great deceivers, because cost is utterly subjective, and because there is no social mind. The notion of multiplying some price times some quantity bought by some number of people and calling the result “social cost” or “social benefit” is completely misleading. Here’s why:
1. Market prices are frequently not observable because there is no single market; most exchanges of money for goods do not occur in what some economists call “perfectly competitive markets” such as the markets for field crops like corn and wheat; most exchanges of money for goods occur at a variety of dollar prices, such as the so-called market for gasoline, with different dollar prices at different gasoline stations located as close as one city block away. In general, there is no observable, objective market price. At best there are multiple prices. Can’t we just take an average and call it good enough to conduct CBA? Yes, if we’d like to mislead people, we can; some economists who conduct CBA do exactly that. I used to be one of them.
2. Far more people in a society are not at all involved in a set of exchange transactions than are involved; claiming that we can extrapolate from those who were involved to all members of society is incredible, even if the tally of prices times quantity actually could measure value, but alas, it cannot.
To sum up, cost and price are not the same thing, even though they have a relationship, not twins, maybe more like cousins or second cousins. Cost is irretrievably subjective, a mental phenomenon experienced by a unique individual, even though price is objective, and sometimes is paid or received by multiple individuals.
Cost cannot be translated to dollars in markets, thereby making cost objective; neither can benefit. Cost benefit analysis magnifies the error of claiming cost is objective by adding up prices times quantities bought and sold and mistakenly declaring the result to be social cost or social benefit. If someone purports to have conducted a cost-benefit analysis, look away. More is being claimed than is possible.