Saturday, January 2, 2016

THE DEMAND WIZARD

by James Craig Green

How Free Trade Increases Value
My friends and colleagues Paul Prentice and Penn Pfiffner are professional economists. They were both Senior Fellows at Colorado's Independence Institute when they developed their Free People, Free Markets courses several years ago. Paul, still a senior fellow in Colorado Springs, teaches a three hour version of the course, and Penn, in the Denver metro area (no longer affiliated with II) teaches a longer version.

I have taken both courses twice now, and learned something new each time. I last took Penn's course on two consecutive Saturdays in Longmont, Colorado in 2011, and originally took his 4-week course in 2007. I have also gone to Colorado Springs twice now to see Paul's "Three Hour Tour" (Independence Institute President Jon Caldara calls it the "One Night Stand").

One of the most interesting features of their courses is a segment called the Demand Wizard. It reveals an elegant insight into market economics most people never think about, even longtime advocates of free market economics. It can be a struggle to explain how markets work, especially to those who think government should heavily regulate them. The Demand Wizard makes it easier to understand.

As shown in the following YouTube video, Penn Pfiffner plays the part of the omniscient (all-knowing) Demand Wizard who attempts to allocate wealth to improve the economy. The demonstration begins with four food products (coke, chips, cookies and yogurt), each of which sells in stores for about the same price. The Wizard hands out one of these things to each student in the class. This unique demonstration illustrates the variation and importance of each person's subjective opinion of value and its contribution to an objective market value (about which too many economists haven't got a clue). If the links have changed, or otherwise don’t work, enter either Penn Pfiffner Demand Wizard into your search engine, or for Paul’s video (next page), Paul Prentice Demand Wizard.

(Penn Pfiffner 4 minutes)

As the famous Austrian economist Ludwig von Mises pointed out in Human Action, each person places a subjective value on everything he wants or uses, which is unique to him and varies with time, place and conditions. For example, when you are at home, a glass of water costs you practically nothing, because your monthly water bill may be less than a penny per gallon. However, if you are at a sporting event or concert, you may pay two or three dollars for a small bottle of water. If you were extremely thirsty and a store was not convenient, you would gladly pay more. This concept is at the heart of millions of sales and purchases each day that comprise the American - and World – economies when prices are allowed to change with variable supplies and demands, as previously discussed in Chapters 2, 4 and 6.

Demand Wizard Results

As you can see from Penn's video, when the Demand Wizard selects which products each member of the class received, the total value of this mini-economy was 25 units, based on each class member assigning a relative value from 1 (least preferable) to 4 (most preferable) for each of the four products handed out. This ranking is done prior to the re-allocation of the same products based on free trade among class members (representing the dynamics of market economies) according to their different (subjective) individual preferences.

After class members were allowed to trade the items, the total value of the class economy almost doubled to 47 units. This is but a small, simple example of the awesome power of markets to satisfy people's desires without forcing other people to pay for them. It is important that this overall increase in total (subjective) value occurred without any new production of goods and services; only their more-efficient distribution by a voluntary market process from the Win-Win transactions between traders acting in their own self-interest.

Paul Prentice also presents the Demand Wizard exercise in his classes, with similar results, though the numbers vary from class to class. Please note this simple example involves only four products, contrasted with the large number of economic decisions people make every day. It was Paul who first brought the Demand Wizard concept to the FPFM classes. Also, the increased wealth from this example does not consider increased production and innovation from profit incentives and the freedom to pursue them – further market benefits not shown here.

In this three minute video…
(Paul Prentice 3 minutes)
…from a presentation at the Independence Institute, Dr. Prentice explains the connection between property rights and human liberty, which counters popular arguments that they are contrary to each other.
 
Objective (Market) Value from Individual Subjective Values
The Demand Wizard demonstrates an important principle that few people understand, including a lot of economists. From the subjective, individual, whimsical choices made by many people, a market develops - a voluntary collective in which each person trades by his own whims and temporary choices. But, the collective action of many such choices produces an objective value that is measurable and produces a permanent record that can be seen by anyone. That is the "market price" of any given product, service or commodity at any given time. The stock market is an example. So is a store that sells anything. When demand falls off, the store owner may lower the price, even below his cost if necessary to get rid of inventory that is not selling. When demand picks up, he may raise prices again. These prices are the objective value of something or things in a market, integrating hundreds or thousands of subjective individual decisions. They may remain constant for long periods of time, or they may vary each hour or day, depending on the changing supplies and demands that produce changing prices. Ebay auctions are excellent examples of rapidly-changing prices among many different bidders.

This is something no Commissar or other pretend Demand Wizard can possibly do, because no one has the complete knowledge necessary to make timely, self-interested decisions for someone else. However, politicians, lobbyists, regulatory agencies and other special interest groups daily make deals, supposedly in your interest, but always in their own. This process cannot possibly produce a better outcome than having individuals or voluntary groups make their own decisions each day about what to buy and what not to buy or trade with their own money or other resources.

Simply stated, the complex dynamics of individual economic choices cannot be modeled in all its complexity and uncertainty. This is why, though some economists have better track records than others, no one can predict future prices, supplies or demands without some error, due to the subjective nature of individual opinions of value. Although the collective results of these individual subjective opinions of value can be recorded and expressed as historical data, their repetition cannot be accurately predicted with reliable certainty. This is why the most successful investors, buyers and sellers of all goods and services must hedge their bets with contingency plans for altering projections based on comparing recorded historical results with actual performance, which may change rapidly. Businessmen and other free traders produce net positive wealth by making timely changes to their plans in response to market fluctuations.  Businessmen who fail to respond to these responses are more likely to fail.

Unfortunately, these choices are denied by government for its services, imposed on society by force of law and the threat of jail for non-compliance. It almost always results in less overall value than the individuals whose personal assets are at risk, such that they have an incentive for changing their opinions of value frequently to conform to post-transaction realities.

It is the denial of individual choices and the lack of personal involvement (risk of loss) in goods and services that creates the oppressive damage government does to economies in the name of the nebulous public interest”. It is naive to believe that 1) politicians have your best interest as their primary goal and 2) that they and their so-called "experts" armed with Keynesian economics or other collective fantasies can know how to allocate goods and services with any precision, timeliness or accuracy. A lifetime of applied Keynesian theory by government has resulted in unprecedented, unsustainable public debt (including unfunded liabilities) between 50 and 120 Trillion Dollars, as discussed in Chapters 1-3.