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Value Theory

Value is a central concept in economics and a theory of value will play an integral part in any economic paradigm

Value is a central concept in economics and a theory of value will play an integral part in any economic paradigm

Value theory within economics represents all theories that try to define what economic value is, where it comes from, why goods and services are priced the way they are and how to calculate some form of objective price; if such a value exists.1 In this article we look at the two major paradigms to the theory of economic value, the standard extrinsic paradigm based around the idea of utility and the alternative nonlinear paradigm of intrinsic value.

Extrinsic value

The theory of extrinsic value, also called the subjective theory of value, is a theory which advances the idea that the value of a good is determined by the importance an acting individual places on a good for the achievement of his or her desired ends, what is called utility. The theory of extrinsic value posits that value cannot be measured or observed directly. So instead, economists devised a way to infer underlying relative utilities from observed choice, called revealed preferences. The economist Alfred Marshall put it like this: “Utility is taken to be correlative to desire or want. It has been already argued that desires cannot be measured directly, but only indirectly, by the outward phenomena to which they give rise, and that in those cases with which economics is chiefly concerned, the measure is found in the price which a person is willing to pay for the fulfillment or satisfaction of his desire.”

Consistent Choice

An important component to this theory is what is called consistent choice. Once an agent’s preferences have been revealed, they are not allowed to change unless the properties of a good they are evaluating changes. If I prefer an apple to an orange now, I cannot change my preference unless some property of the good changes. But if all the properties stay the same and instead we add a banana to this set of choices and I then make the choice again, I am not allowed to choose the orange this time because in both cases I did not choose the banana. It is considered not part of the optimization equation, and thus cannot alter my choices. The banana is exogenous to the equation. It is part of the context, and within this model that context cannot alter what happens in the equation. What this means is that the value of something is in the properties of that entity and people’s perception of them. One is not allowed to change one’s evaluation of the item unless its properties change. If you suddenly notice that the apple has a little blemish on it, then its properties have changed and you can change your evaluations of it and choose another option that is considered rational.2

Context

Put more formally, if an agent chooses X over Y then whenever X and Y are available she will always choose X over Y. What this makes explicitly is that the context cannot change the evaluation of things. The context cannot add or subtract any value. As long as this condition of consistent choice holds, we can then model agents’ behavior in terms of optimization over a set of choice and we will get a closed form solution. In our previous example, because the banana should not have affected my choice, we can abstract way from the particular context within which the choice is being made, assuming that this context does not add or subtract value to the properties of the goods under evaluation, and thus we don’t need it in our model.3

Markets

The standard theory of value can be best conceved of as a result of an hypothetical auction for the item

The standard theory of value can be best conceived of as a result of a hypothetical auction for the item

Because utility is always defined through revealed preference, it always exists with respect to someone or some organization. Objective value is then defined through the interplay between people’s utility function, that is to say, the interaction between producers and consumers trying to maximize their own utility creates what is called a market, and the market defined the economic value of something, what we call its price. The benefits of this model to value are many. Most importantly, it gives us a very simple way to objectively evaluate something. This extrinsic value model gives us a very compact, clean and robust mechanism for objectively evaluating something.
Another important part of this idea of the market as defining price is the law of large numbers. It is assumed that the more people we have in this market, the more information we are bringing into the equation, and thus the more the interplay between all these different subjective utility functions will approximate some kind of real evaluation of the good. And this is a central idea in the efficient markets hypothesis. The more people in the market and the more completive they are, the more information we will have and the closer we will approximate some kind of objective evaluation. This whole framework of extrinsic value theory is critical to achieving abstract mathematical models of markets as equilibrium points, which is of course, central to the enterprise of standard economics.4

Intrinsic Value

Utility always defines value in relation to someone. Thus, within this model something cannot have value independent from someone desiring it, which is especially the definition of extrinsic value. When value is defined by the interaction between different well-defined utility functions, this means that the thing does not have an intrinsic value. Thus, the value of an entity cannot be dependent upon something else. It cannot be dependent upon the context, as was illustrated with our banana example previously. And this is where the theory and the data diverge. Many experiments from behavioral economics will tell us that value does in fact change depending upon the context. And not only this but value may in fact sometimes be fully defined by the context.
For example, the value of a color is dependent upon what color is placed next to it. The perceived value of a product in a magazine is dependent upon the other products in that magazine that they were never going to purchase, but the price and quality of those other products did create the context for their evaluation of the item that they did purchase. With hyperbolic discounting our preference for different payoffs is dependent upon the context of time.5

Nonlinear Value

This phenomenon that value is not just dependent upon the properties of something in isolation but also upon its context is everywhere and very intuitive to us, but incorporating context as a defining factor in value would lead us to a whole new paradigm called intrinsic value, where the value of something can be at least partially independent from the value ascribed to it by some agent in isolation. With intrinsic value theory, the change in value may derive from the item’s relations to other things, and thus dependent upon those other things what we can call the context. Thus, this context can in fact, have some value and it can add or subtract value to any individual item within that context. Allowing for this empirical fact will give us very different models, where value and preferences are dynamically changing depending on the connections and context.

Value In Connections

Within this intrinsic value paradigm, value is in how things are contextualized – culturally, socially, environmentally and technologically. We will take some examples of this to solidify it. I want to be a lawyer because it is a socially respected job. That job is giving me access to a culturally respected identity. In other words, through that job I am gaining access to cultural capital. Every time another person joins this culture and believes that my job as a lawyer has prestige, the value of the job goes up, not because it got any better or I get paid more but because the network that I am getting value from has grown. I choose to wear a suit to work because that is what everyone else at my workplace does. The thing that is the suit is giving me access to social capital, derived from being part of this in-group. I buy a tablet computer because it will give me access to the Internet.
The value of these things is really in the fact that they give one access to a network that has value as a whole – the Internet, society, my culture, the natural environment etc. In all these examples the value is actually in the integrity of the entire network, not a property of the thing. Every time another person joins Facebook it makes my account with Facebook more valuable. My account has not changed but the network’s value has. And because the value of my account is in it, access to that network – its value – has gone up. This is what we call the network effect, where the value comes from the network. The network is just another word for the context, a set of connections that add or subtract value to the item.

Disconnections

May of the least desirable jobs are so because they only offer a single value proportion, disconnecting people from social and cultural value streams

May of the least desirable jobs are so because they only offer a single value proportion, disconnecting workers from social and cultural value streams

If things then have value in their connections, the inverse is also true. By disconnecting them, we will reduce their value. Many of the jobs that are considered undesirable are so because they only give economic value. Cleaning the street is such an activity. It has very low social status. It has no enduring value as it will be rubbished again tomorrow and you will have to do it again. You will also have to live with the fact that some machine could probably do the job better than you. All of these reduce the psychological or what we might call cultural capital received from that activity. And due to this, we will have to pay people a financial reward, and that is all they are getting in remuneration from this activity because they are disconnected from any other network that might add value to this activity.

Value of Integrity

Because the value is in the connections, it is both in your access to the network and the integrity of the network. If we were to disintegrate the Internet by disconnecting servers or cables, the value of all the devices connected would go down. Or if we believe the organization we form part of is without integrity, the value to us of our social status within it will also be devalued. And as we will be discussing later, the value of the whole system is often an emergent phenomenon, which requires all the parts to be working together in an integrated fashion. Out of this we get the emergent value of the whole system. When we disintegrate the system this emergent value no longer exists, and the value of all the components in the system is reduced.
This intrinsic conception of value is what we call wellbeing. Wellbeing is a very complex phenomenon. The value that it represents is a distributed one. Wellbeing is not the property of a thing. It is what emerges out of forming part of or having access to many different services, ecosystems services, industrial services, social and cultural etc., but it is also in contributing to those systems, co-creating value within them. The value that emerges is a complex interaction of different forms of capital.

Process

The value of something is not just contingent on its context within space but also its context within time. The standard model is very much a static one. Time doesn’t inherently change the value of things. In the static model, value just exists and people want it. If they get it they will be happy. It is assumed that agents will always try and achieve it at the lowest possible expense of resources, and thus within this model there is no value in the process of achieving it. But this is in contrast to empirical data, where we often see that the value of a thing is created during the process that people go through in trying to achieve it. For example, in experiments that have been done with participants building things, like Lego toys or origami figures, the participants who engaged in this process valued those things more than those who did not engage in the process. And those who had harder tasks valued the end product even more.
In experiments, it turns out that people have to be paid more to do repetitive tasks that have no lasting outcome. As soon as you add some element of endurance to the finished product, so that they feel like they are part of an enduring process, this gives meaning to what they are doing and they will be more motivated, being prepared to work at a lower cost. This is an example of cultural capital. It gives us a sense of direction and self-realization that adds value to what we are doing. With cultural capital, value is in fulfilling some motivation, and this motivation plays out over time. It is a process. The value is contextualized by that process.

Emergence

The sense of achievement one gets when one goes through the full process of creating something might be an example of an emergent phenomenon. The integrity of that whole process adds some value to it. In contrast, when we divide the process up through specialization, asking a worker to do repetitive tasks on a production line, they become alienated from the end product, and receive no value from it. What I am trying to illustrate with this example is that as with our previous example where value was added by the integrity of the context in space, the same is true of time where the value is in the continuity of the process and that emergent phenomenon adds value to any component within it. Like all emergent phenomena, this is nonlinear. The whole is greater than the sum of its constituent parts. By performing or maintaining that whole process, we get that emergent value. Value is added by the integrity of the network.

Context

Our standard theory of value was formalized within the context of the industrial age, where the mass production of discrete, tangible goods was at the center of economic activity. These discrete products could be easily given a homogenous quantified price. Due to a lack of information, this model of the market was an ideal mechanism for defining an objective value in the form of a single price metric. Today a number of different factors are converging to put stress on this traditional paradigm to value. They include most of the major trends that we previously highlighted – servicization, information technology, the knowledge economy and sustainability. Information technology is making it ever more explicit that value is in the networks of connection, such as the Internet or social networks. In an interconnected world, it is increasingly explicit that access and connections are what people want, instead of the ownership of discrete tangible product.

Information & Services

Information technology is fundamentally altering our capacity to valorize things and offering the possibility for quantifying and in incorporating a wide spectrum of value streams into product and services.

Information technology is fundamentally altering our capacity to valorize things and offering the possibility for quantifying and incorporating a wider spectrum of value streams into products and services.

Information technology in the form of big data is giving us quantifiable values to all sorts of things that we never had previously, how many people like a business’s Facebook page (which is social capital), how environmentally friendly a product is and how much people are prepared to pay for that (ecological capital). In big data, we have the capacity to reveal the value of things, and we are not just talking aggregate values. We may soon have individual personalized values associated with different individual goods and services. Amazon, the online retailer, already uses sophisticated algorithms to adjust the price of products for different customers. Depending on information they have about your profile, what device you are using, what time of day it is and so on they may adjust the prices accordingly.
This is what servicization means, instead of selling a single product, access to a service is sold instead, and that service is really a network that aggregates many different things in order to deliver a complex form of value to the right person in the right context. Added to this is the knowledge economy, which requires a new skill set of intelligence, self- motivation, meaning, context creation – all of which can’t be brought about with reference to extrinsic value. They require the harnessing of motives through intrinsic value.

Applications

We have outlined two forms of economic value: One extrinsic, that is defined in terms of the value that an agent ascribes to an entity due to its properties in isolation, what is called utility. Within this formalization value is a homogeneous variable. It is derived from a single source, the properties of the good or service, and made manifest within prices that represent the interplay between different people’s utility functions. We have talked about an alternative formulation of value called intrinsic value that emerges out of the network of connections that the entity is embedded within, and this value changes depending on the context. Within this model value is heterogeneous. It is derived from a network of interacting social, cultural, industrial and ecological capital.
Both theories of value have their advantages and disadvantages that will make them applicable in different circumstances. Extrinsic models will often give nice clean closed form solutions, but we can’t always use them, as the extrinsic model will run into the problems of market failure due to the fact that markets can’t define intrinsic value. The intrinsic model to value doesn’t suffer market failures and it is much more representative of empirical data, but it is also much more complex. In many cases, we don’t really have the models to fully define them. In order to instantiate them, we are likely going to need a lot of data, and again we often don’t have this. But with the rise of big data and advanced analytics, it is very likely that we will increasingly have this in the future.

Cite this article as: Joss Colchester, "Intrinsic Value," in Complexity Labs, October 4, 2016, http://complexitylabs.io/value-theory/.

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2017-05-05T09:56:41+00:00