Principles of Economics — Lecture 2 (Value) • Study Notes
By Saifedean Ammous
Big Picture
- Subjective value is the cornerstone of Austrian economics.
- Marginal analysis (from Carl Menger, 1871) marked the shift from “old economics” to modern economics.
- Value is not inherent in goods — it arises from human judgments about how well something satisfies needs.
- Scarcity forces us to economize, and valuing is the act of ranking goods to maximize satisfaction.
Core Claims
- Definition of Goods & Utility
- A good satisfies a human need.
- Utility = the capacity of a good to satisfy those needs.
- An economic good exists when demand > supply.
- A non-economic good (like air or abundant river water) exists when supply > demand.
- Scarcity Is Permanent
- Easier to desire than to produce (Ferrari vs. imagining one).
- Our wants are limitless and costless, production is costly and difficult.
- Therefore scarcity never disappears — we always face trade-offs.
- Value Is Subjective
- Value = a mental construct, not an inherent property.
- Example: Oil was once waste (negative value), became vital with engines, dipped negative again in 2020.
- Value exists only in human consciousness, not in the good itself.
- Ordinal vs. Cardinal Value
- Austrians: Value is ordinal (ranked preferences).
- Mainstream: Tries to make it cardinal (numerical “utils”), which is meaningless without real units.
- Quote (Mises): “A judgment of value does not measure. It arranges in a scale of degrees.”
- Price vs. Value
- Price shows an upper and lower bound of value at the moment of exchange.
- Buyer values the good more than the price; seller values the money more than the good.
- Mutual benefit proves value is subjective.
- Labor Theory of Value Rejected
- Marx: value comes from labor input.
- Counterexample: Mud pie vs. apple pie — equal labor, radically different value.
- Labor contributes to production, but doesn’t create value. Value depends on meeting human wants.
Marginal Analysis
- Each additional unit of a good is valued less than the previous one.
- Law of Diminishing Marginal Utility:
- First meal after starving = life-saving.
- Second meal = still vital but less so.
- 25th meal = no value.
- Total utility rises, but marginal utility declines.
- Least Valuable Use Rule:
- Purchases reflect the least important satisfaction a good meets at the margin.
- Explains why water (essential) is cheap, and diamonds (luxury) are expensive.
Examples & Paradoxes
- Water-Diamond Paradox
- Water sustains life yet is cheap.
- Diamonds are non-essential yet expensive.
- Answer: We don’t choose between “all water” vs. “all diamonds.”
- We choose between marginal units. Water is abundant → cheap at the margin. Diamonds are scarce → high marginal value.
- Iron vs. Gold
- Iron underpins infrastructure but is cheap.
- Gold serves jewelry/luxury but is expensive.
- Marginal units explain the difference: extra iron is nearly worthless, extra gold is highly valued.
Quotable Ideas
- “Value is not a property of goods. It is a judgment economizing men make.” — Carl Menger
- “Value does not exist outside the consciousness of men.” — Menger
- “A judgment of value does not measure. It arranges in a scale of degrees.” — Mises
Study Prompts
- Define an economic good vs. a non-economic good.
- Why is scarcity permanent?
- Explain why value is subjective and not inherent in goods.
- Contrast ordinal and cardinal value.
- How does marginal utility solve the water-diamond paradox?
TL;DR
Value is not in objects — it is in us. Goods are valued according to how they satisfy human needs, and that valuation depends on scarcity and context. Scarcity forces economizing, and marginal analysis shows that each additional unit of a good is worth less than the previous one. This explains paradoxes like cheap water and expensive diamonds. Austrian economics stands apart by insisting: value is subjective, ordinal, and rooted in human choice — not labor, not equations, not imaginary “utils.”