Praxeology - Episode 11

Translations of this material:

into Russian: Праксиология Эпизод 11 — Закон отдачи. Translated in draft, editing and proof-reading required.
Submitted for translation by IrinaChernykh 15.06.2015

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How do we derive the utility of a producer good?

Hi guys, Praxgirl here.

In our last lesson, we covered the Praxeological concept of valuation known as Utility, understanding the nature of marginal choosing, and how goods of the same class get ranked by acting individuals in an idea called The Law of Diminishing Marginal Utility.

This Law, derived at by deduction, gave us the power to understand how man determines the Utility drawn from a unit of a homogeneous good. This understanding can explain problems that were previously thought of as “paradoxes of value”: for example, why a cup of water is less expensive than a diamond, when water is essential to life and diamonds are mostly used as jewelry.

In this lesson, I’d like to continue expanding your knowledge of how utility is derived from the means that contribute to satisfying an end but are not directly consumed and therefore do not directly satisfy an end. The question I aim to answer could be posed like this: How does one determine how much utility one of the machines that milled a diamond has to an actor?

CONSUMER GOODS AND PRODUCER GOODS

The means we use satisfy our ends we call goods. We can classify goods into two main categories: consumer goods and producer goods. Consumer goods are those goods that are used directly by an actor to satisfy an end. Producer goods are those factors which are combined with at least one other factor to create a definite quantity of a consumer good.

For example, a ham sandwich is a consumer good. You eat the ham sandwich to directly satisfy your hunger. The bread, ham and labor you employ to produce the ham sandwich are the producer goods or factors of production.

HOW TO DETERMINE THE UTILITY OF A GOOD

If one wants to find the utility derived from any unit of a homogeneous consumer good, all one needs to consider is--first--the fact that human action is an exchange. It means preferring one thing over another. Or in other words, the cost of choosing one end is determined by whatever other end you could have chosen. Second, that action determines what a man values most--because logically--what he did must be considered what he thought was most urgent. And lastly, that these preferences can be arranged into a scale. This scale shows us that because the more urgent want is satisfied first, each successive end must therefore be less important. Therefore, a unit of a means that directly satisfy an end aimed at by an actor (consumer good), will command a diminishing value to the actor.

For example, suppose Jerry wanted to rig his house with televisions. The first television he bought would go to satisfy his most urgent end. In this case, he would put the television in his living room to watch with his family. If he bought a second television, he would place it in his bedroom to watch before going to sleep. A third television could go in his kitchen to watch while he cooks. Now lets suppose he had to give up one of the televisions, maybe because your his utilities bill is too high, then the first television he would get rid of is the one that satisfies the least urgent end, which in this case is the television in the kitchen. If he had to get rid of one more television then he’d get rid of the one in his bedroom, before the one in his living room.

If we switched the example around--and have Jerry get rid of his bedroom television first-- this does not violate the principle of what we’re saying but merely adjusts the idea to reality. We must therefore conclude that it was in fact his bedroom television that was servicing a less urgent want and that Jerry valued his kitchen television more than his bedroom television while his living room television remained his highest or most important end. The point is that we can know with logical certainty that each successive television will satisfy one of Jerry’s lesser urgent wants.

This is known as The Law of Diminishing Marginal Utility.

MARGINAL PRODUCTIVITY

We now understand that the value of consumer goods (means that satisfy ends directly) are their marginal utility to the acting individual. This utility always diminishes with each successive unit, and there is no way to calculate this fact arithmetically. There can be no adding or multiplying. In the case of Jerry, only he and he alone decides (through action) where he will put the next television he buys.

Now let’s turn to the case of producer goods (means that satisfy ends indirectly). First, we have to acknowledge that there is no way of deriving utility from units of a homogeneous producer good because they are not directly consumed. They don’t satisfy ends directly, but only contribute to producing a final product which satisfies ends.

So for example, while we can say that the marginal utility derived from Jerry’s televisions each serve a lesser desired end, we couldn’t say that Jerry derives a constantly diminishing utility from a power supply of one of his televisions, because Jerry isn’t directly consuming the power supply.

To determine the value Jerry derives from a power supply, we need to consider how much value Jerry would be losing if he had to buy a television with no power supply. In other words, the value of each marginal unit of power supplies would be equal to the end satisfied by the marginal unit of one of Jerry’s televisions. The utility of a marginal unit in a producer good is derived from the utility of it’s marginal product. The value Jerry is getting from a unit of power supplies is called its marginal productivity.

MORE DIFFERENCES BETWEEN CONSUMER GOODS AND PRODUCER GOODS

As we stated earlier, goods are simply scarce means used to satisfy our ends. The very fact that we need to produce consumer goods implies that producer goods are scarce as well. So going back to our example with Jerry, we could say that the very fact that Jerry has to decide what do with his limited supply of televisions implies that there is a limited supply of plastic, glass, power supplies and so on.

Things that render unlimited supplies are not goods (means) at all! For example, the knowledge to make coffee is not something anyone has to economize. The “recipe” for how to make a cup of coffee is never exhausted. The only things we can run out of are coffee beans, filters, water etc. We must economize these goods.

We also mentioned that a producer good must be combined with at least one more producer good to create a consumer good. This is because if only one producer good were needed to create a consumer good, then it would be a consumer good itself!

THE LAW OF RETURNS

There is a key concept that can be derived from understanding the fact that producer goods at all times must be combined with at least one other producer good: while we cannot add, subtract or multiply value and utility, quantities of homogeneous units of a supply can be measured! Therefore it follows logically that at some definite point the marginal productivity of producer goods reaches a optimum point.

That is, if we keep all other inputs fixed and keep on increasing the quantity of one producer good by one unit, then at some point an optimum level will be reached where each additional unit of that producer’s good can no longer increase it’s marginal productivity.

This is known as The Law of Returns.

Here’s an example.

Suppose that Patrick wanted to dye his t-shirt red. In order to accomplish this, he would have to have a certain quantity of red dye. A greater or lesser quantity of dye wouldn’t help Patrick to achieve his end. If he had too much dye, he would have to leave extra dye unused. In this example there would be no returns at all for any extra dye because they would no longer contribute to the end sought.

If Patrick didn’t have enough dye, then he could only color a part of his t-shirt. Each additional unit of dye would have an increasing marginal return until the point in which he could actually dye the entire shirt red.

It should at this point be easy to imagine a situation where the opposite of increasing returns occurs. For example is a machine needed a minimum amount of oil to run, then adding more oil would have an increasing marginal return until the point of optimum return. Adding a little too much oil would not make the machine stop running instantly, but each additional unit of oil would have a diminishing return or productivity to contribute.

What these optimums are must be determined by technological experience and are outside the realm of Praxeology, but The Law of Returns, the fact that scarce producer goods MUST have an optimum output is one arrived at through logic.

SUMMARY

As we can see, determining how men value means (whether they are directly consumed goods or indirect producer goods) can be understood logically through the categories of purposeful action. All we must do is consider value starting from ends, working through consumer goods and then through factors of production. We can conclude that the utility of a producer good is its contribution to the product!

This conclusion, including the fact that definite producer goods have an optimum output will become more important once we start talking about markets and why products that seem almost indistinguishable have varying prices, and how all of this plays into the concepts of profit and loss. Nevertheless, they are indispensable logical implications in the science of Praxeology.

I’ll see you guys in the next lesson.