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.
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.
