Paradox of value

"Life is a sum of all your choices"
~Albert Camus.

My initial plan was to examine the cost of buying a car in my next post but I chose instead to address a different subject. I may still get to the car today but I wanted to explore an observation of human decision making that has puzzled economist for decades. To introduce this to our readers I will start by posing a question.

Suppose a complete stranger walks up to you and says: "How much would I have to pay you to live the rest of your life without legs?" (Forget the pain factor, just assume you had to go the rest of your life without legs).

How much would your legs be worth? One million? More? Twenty Million? Would there be a price you are even willing to accept? Truthfully most people could come up with some number that they'd be willing to accept to live the rest of their lives without legs. Take a moment to try to figure out this "magic" number for yourself.

Ok. Now that you have that number in your head lets ask the exact same question worded in a different way. Suppose you were taken by force, trapped in a room and someone said how much would you pay me to be able to keep your legs? Now what is your answer? How much of your savings are you willing to part with? How much money would you borrow? Would you sell your house, car and other belongings in order to keep your legs? At some price you would agree it is not worth it and decide to go the rest of your life without legs.

Logically both questions are asking the same thing: What value do you place on being able to live the rest of your life with legs? Interestingly enough, nearly EVERY person responds with a much higher number in scenario #1.

Obviously this is not a very realistic situation but we can use this irrational behavior to observe many irrational decisions people make on a daily basis. Lets examine a similar situation that most people would face. Think about your yard and approximate how much work it would take to mow and trim your yard. Since you are likely the one that does this work you probably know how much work it takes to get your yard in tip top shape. Now suppose for a second it was not actually your yard, how much would someone have to pay you to get up every Saturday, go across the street and mow this yard? This is a very common situation many home owners are in. They hate mowing grass and if offered $50 to mow their own grass they would never accept the offer. The trouble of buying a lawn mower, paying for gas, maintenance on their equipment and two and a half hours of work every Saturday for a measly $50 a week is simply not worth it. Yet these very same people get up every Saturday and happily mow their own grass and would never "over" pay a yard man $50 dollars to do the job. The very same job they would not accept themselves if it wasn't their yard. This does not make any sense. If there is a job you would not do for the price you can pay someone else to do for you, this creates an efficient exchange. The person who was paid to do the job feels it is a good deal to complete the job for $50 and the person who avoids having to do the work is happy to part with $50 in exchange for not having to do it himself. Both people are better off.

This does ignore the fact that some people actually like keeping their own yard and the satisfaction of a job well done. Also when you pay someone else to do the job for you it's likely they won't do it "the way they like it". If people more closely examined the work they do around the house they may find some of the services out there are much better deals than they initially seem. Next time you are thinking about purchasing a service, do this comparison for yourself. Think to yourself, "How much would someone have to pay me to do it?" If that number is more than you are paying, it is likely a good deal. Incidentally this also happens to be a very good sales tactic. Position your product or service in a manner than gets the person to realize how much someone would have to pay them to do it, then they are much more likely to realize that it is worth it to have you do it for them.

I leave you with one last anecdote that is often use to argue against free trade and illustrates some of the "evils" of free exchange of goods and services. Similar to the first situation suppose some rich guy, who is obsessed with punching people in the face, comes up to you and offers to pay you $10,000 to punch you as hard as he can in the face. You accept, he is glad to pay the $10,000 because he actually gets $15,000 worth of enjoyment out of punching people in the face and you are happy to be punched in the face because a few days of pain is well worth $10,000. Now here is the tricky part, according to economic theory if he punches you in the face but doesn't pay the world economy (consisting of you and him) is still better off. The simple fact that you are willing to be punched for $10,000 means that you price the pain of being punched in the face at less than or equal to $10,000. We know Mr. Rich who likes to punch people in the face is willing to pay $10,000 that he values the enjoyment received from punching people at or greater than $10,000.

To show this in equation form lets suppose that you would be neutral about getting punched in the face at a price of $3,000. Meaning you would be just as happy to get punched in the face and have $3,000 as you would not not be punched in the face and not have $3,000. Since you are getting paid $7,000 premium in this situation it is a great deal for you. The man who enjoys face punching gets $15,000 of enjoyment out of punching people. So he is neutral at a price of $15,000 between being able to punch someone or keeping his $15,000.

An equation of the exchange would be as follow.

(payment received) - (pain caused) + (enjoyment) - (Payment) = Economic Surplus

In a situation where the man pays there is economic surplus of $13,000.

10,000 - 3,000 + 15,000 - 10,000 = X
7,000+5,000 = X
13,000 = X

But if the man doesn't pay, there is still surplus because the pain caused is less than the enjoyment received!

0 - 3,000 + 15,000 - 0 = X
x= 12,000.

In this example proponents of fair trade would say that right now developed countries can be compared to the rich man who enjoys punching people in the face. They are running around punching people but not properly compensating them. If we were to adequately pay for there would still be plenty of surplus to go around it would just be more evenly distributed between the people in relative position of power and those unable to defend themselves. Would you be willing to pay an extra $2 when you purchased a t-shirt from Wal-Mart if you knew that extra two dollars could double the standard of living of a child in China or would you prefer to buy the shirt a the current price and use your the surplus to join an "adopt-a-child" program knowing that $.50 cents of every dollar donated goes towards administrative costs of running the charity.

I happen to support free-trade for various not discussed here but it is some food for thought....

TRC