Why Prices Don’t Measure Value

In a perpetually inflationary economy, politicians and policymakers love to spread fallacies related to market prices. Whether they’re blaming business for inflation or downplaying the costs of tariffs, they frequently rely on the false premise that prices are somehow “measurements of value.”

The following article was originally published by the Mises Institute. The opinions expressed do not necessarily reflect those of Peter Schiff or SchiffGold.

With a few exceptions, several epistemological procedures in the science of economics are heavily swayed by the gale force of empiricism or logical positivism. Consequently, we increasingly find the science of economics compartmentalized into various methodological schools which, to various degrees, are keen on importing the methods of the natural sciences at the expense of the actual task of economics.

Within economics, there are entrenched methodological frameworks that heavily favor measurements with the aim of making so-called “falsifiable” empirical predictions. This tinkering with positivism in the study of human action has led to a widespread tendency to misconstrue prices as measurements of value, given the tight link between the two. It is the task of this article to refute this widespread fallacy and to reestablish the clear distinction between the praxeological categories of “value” and “price.”

What Makes Measurement Possible?

Measurement presupposes an immutable standard upon which reckoning is made in relation to changing entities. In the natural sciences, there exist standards which are relatively fixed, and which are subsequently employed as media of establishing magnitudes and various degrees of quantitative relationships between entities (e.g., space, volume, length, width, time, etc.). The condition of fixity in certain natural phenomena makes it propitious for the physicists and theoreticians of the various natural sciences to conduct scaled experiments and make testable predictions.

However, the state of affairs is different in the field of human action, the subject matter of the social sciences and economics. Here, the full conditions warranting measurement are not present. Phenomena in the domain of human action are outcomes of complex interplay of factors whose specific quantitative relationships are not easily accessible to the inquirer. Put simply, we are not able to discern the constant relations that would make measurement feasible within the domain of human action. And, even if constant relations are apparent under certain conditions, they are merely historical and not theoretical.

In addition, the science of economics is not in want of scientific methods of measurement, but rather due to the nature of the object of its study—human action—is deprived of conditions under which measurement techniques are applicable. Mises remarks as follows in Human Action:

The impracticability of measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations. If it were only caused by technical inefficiency, at least an approximate estimation would be possible in some cases. Economics is not, as ignorant positivists repeat again and again, backward because it is not “quantitative.” It is not quantitative and does not measure because there are no constants.

The social scientist makes recourse to other methods of establishing knowledge apart from those of the natural sciences. Mises, in highlighting the epistemological procedures of the social sciences, puts it as follows:

The task of the sciences of human action is the comprehension of the meaning and relevance of human action. They apply for this purpose two different epistemological procedures: conception and understanding. Conception is the mental tool of praxeology; understanding is the specific mental tool of history.

Value and Prices

The ultimate springboard of the market process is subjective consumer valuation. Every action within the context of the market is directed to serve the attainment of valued ends—most particularly, the most urgent in the value scales of individuals.

Contrary to the erroneous labor theory of value advanced by the classical economists—which attempts to quantify value by alluding to the amount of labor expended—the value of a good is not determined by the quantity of labor employed in the production of the good. Value is rather the subjective estimate of the importance which the satisfaction of a need bears for the individual. Value is a qualitative, intensive magnitude, graded according to an ordinal scale. Formally defined by Carl Menger in his classic Principles of Economics as “the importance that individual goods or quantities of goods attain for us because we are conscious of being dependent on command of them for the satisfaction of our needs.” Value is thus not open to the estimations of an external arbiter. This consequently precludes any form of objective measurement of value.

A price, on the other hand, is a praxeological concept derived from the category of action known as exchange. Prices are simply exchange ratios—definite quantities of a less-valued commodity which are given up in order to obtain definite quantities of another commodity which is valued much more.

With money as a medium of exchange, this translates prices into a calculable number. Acting man, having gained cognizance of the role played by media of exchange in facilitating the satisfaction of his most urgent wants through trade, substitutes indirect exchange for barter. Thus, money becomes a more satisfactory means toward attainment of ends. Money prices are, then, the outcomes of the aspect of action involving a commonly-used medium of exchange.

Prices are not measurements of value. That value is imputed to the units of a good for which prices are paid does not imply that these prices measure value. The inability to properly comprehend this praxeological distinction between the categories of value and prices respectively—in spite of the tight link between the two—would lead to the erroneous assumption that value is measured by prices. The various prices paid for goods emerge from the fact that definite quantities of these goods are valued as a result of their potential employment for want-satisfaction.

Furthermore, prices have informational property in that they can be used to capture or signal the value which definite quantities of a commodity hold for a particular consumer—that is, the degree of importance of want-satisfaction which is dependent on employment of the good—but they do not measure such value. That prices signal real-time subjective values of many individuals does not constitute measuring value. Measurement is strictly the determination of magnitudes in cardinal numbers. Value, on the other hand, is ranked, and represented in ordinal numbers.