Saturday, January 5, 2013

The Law of Three

I spent a fair portion of my break arguing with my father about economics, and at one point caught him defining "value" as the existing "quantity of value."  After brutally teasing him for making a circular argument, I realized that he actually had a valid point. (Even the most obviously illogical statements often conceal a useful principle.) 

He was right because, of course, there are multiple, simultaneous types of value, Precisely, I think there are three: 

Time or labor value is the time required to produce a good. Use or utility value is the pleasure produced by consuming good. Exchange value or market price is the amount of money you could obtain for that good. 

Of course, all three of these types of value have a long and storied history. Aristotle wrote about the exchange and use value of goods, and added an opinion that use value was true, natural, and good, while exchange value was not. Adam Smith differentiated between "natural price" and "market price," defining natural price in terms of labor time and market price in terms of supply and demand.  David Ricardo, and Marx after him, built their theories on time value, and their doom and gloom largely reflects their neglect use and exchange value. The marginalists returned utility to the center of economic debate.

If you read the "About" section of this blog, you'll see that I believe that economies are fundamentally determined by two things: the capacity to produce and expectations. (This post is edited-- originally I added capacity to exchange as a third thing-- but capacity to exchange is really just the market maker's capacity to produce and the creditor and debtor's expectations). These two things correspond to the three types of value. I define the capacity to produce as the amount of utility that can be produced in a given period of time, and thus the capacity to produce defines the relationship between use value and time value. Expectations for consumers, are anticipations of future relationships between use value and exchange value, and expectations for producers are anticipations of future relationships between time value and exchange value. All agents are at once producers and consumers (even if some agents don't really produce much). Once played out, expectations become become price levels. . The relationship looks like this: 

The classic supply and demand graph is really a map of the interaction between time value and market value. The schedule of supply is determined by the labor of the producer, and the intersection of demand and supply is the market price assigned to that quantity of labor time.  You can imagine that use value is graphed on an invisible z axis, and that its level controls inward and outward shifts in the supply and demand curves: 

Thus economics, like nature, occurs in three dimensions. Coincidentally, money also has three definitions: 
  1. Store of Value 
  2. Medium of Exchange 
  3. Unit of Account
Of course by definition money is exchange value, but I do think each of these definitions has more to do with one type of value than any other. Store of value is a store of labor time expended during one period but cashed in at another. As a medium of exchange, money itself is a market maker (see theory), and is thus concerned with the capacity to exchange. As a unit of account, money makes it possible for agents to compare the use value of things relative to each other; regardless of the general price level or the time put into producing something, you will assign a greater money value to a good that you expect to yield greater utility that you would to a good that you expect to yield less utility. 

Einstein was reported to have said: "It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience."  The law of three might just be wishful thinking, but it certainly is quite beautifully simple. 

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