This week’s assigned readings focused around the basics of
economic, and the process of valuation, and the identification of cost in the
economy. This essay reviews those points
that were written about by Alchian, and Sowell.
In the excerpt of this week’s reading of Cost by Armen Alchian, he
writes about cost and valuation in relation to economics. Alchian defines valuation as, “A comparison
among all the available options (each consisting of an amalgam of good and bad)
yields for each option a rank-indicating measure of Value.” (1969, p.404). It is a person’s criteria and view of a
situation that would create these amalgams of good and bad, or as Alchian
refers to them as, “attributes”.
Alchian also defines in his book the term costing, “…the
highest-valued forsaken option necessary to realize that event is fundamental,
for only the latter is cost”(1969, p.404).
This does not just apply to present events. As Alchian delves deeper
into this subject, he explains you can also apply costing analysis to future events
with a present value calculation, using a rate to discount the future value
back to the present. This way, you can
clearly identify the “highest-valued forsaken opportunity” (1969,p.404) in both
present and future.
In reflecting on the intrinsic relativity between value and cost,
I developed a scenario to communicate this.
In this scenario there are two options A & B. Let’s say that A is
valued at 10 good and 4 bad, and B is 5 good and 3 bad. This would create values of 6 for A and 2 for
B. In ranking them according to value,
the result would be A, then B. But the
cost of the options are not the negative or bad value associated with them but
the value of the forsaken option. While
A is ranked first, it has a cost of the value of B since that option was the
forsaken option. While you rank values
from highest to lowest, the cost of the option would also be the highest ranked
value not chosen, if you had chosen B then the cost would be the value of A
given that the value was larger. So the
value of an option can also end up being the cost of a given scenario depending
on the choice an individual makes.
When Alchian reviews the market-revealed values, he is essentially
arguing that with a decline in the utility of a resource, the market will look
to other alternatives that will perform the same function and create a higher
value. He states that, “The incentive to
increase one’s wealth induces shifts of resources to their higher-valued use
until their cost is at least matched by the value of their currently yielded product.”
(Alchian, 1969, p.405). So if the price
of a product increases so much so that the value of it is diminished to an
unacceptable level, people will look for alternatives to increase the value of
that product this in turn reducing the cost to from the marginal value of the
alternative, to the diminished margin of the overpriced version given that is
it the, “highest-valued forsaken opportunity” (1969,p.404)
Sowell refers to the classic definition of economics as, “… the
study of the use of scarce resources which have alternative uses.” (2011, p.2). In this definition resources are limited, so
as the price of those resources climb with scarcity, the value of those options
decline. If an alternative resource can
be used that creates a similar product with a greater utility and value, then
the market will adapt to this new pricing to economize for the alternative. This in turn impacts the cost of those
decisions with the introduction of an alternative, moving it down given that
the next best option is the original with the declining value. Both Alchian and Sowell acknowledge the use
of alternatives in order to drive additional value for individuals. At a high level, alternatives help to drive
efficiencies in economies, in making people or groups economize. This market function is one that is essential
to the preservation of resources, and a driver of ingenuity.
In Sowell’s reference to “institutional ways” he is stating that
scarcity, or as he refers to it as, “unmet needs” (2011,p.3) are present in all
types of economic systems, “…capitalist, socialist, feudal or other kind of
economy.” (2011, p.3). There is no system
that is immune to scarcity. Because of
this inherit economic attribute, everyone, no matter which economic system you
participate in, should be valuing products or materials that they are using. They should also be reviewing the opportunity
cost to ensure that they are not missing out on value that they could
capitalize on. If one does not review
the options in front of them, then they run the risk of not getting the
greatest marginal benefit for the given task.
While assigning value to
options is easy, it is important for information to be disseminated to
individuals who are going to make decisions.
It is also just as important for people to develop alternatives or be
prepared for change in a system where prices fluctuate and can reduce your
marginal benefit, and the cost associated with decisions. If individuals or groups can follow these
fundamentals, they would actively aid in economizing markets and better there
decision making abilities.