Wednesday, October 5, 2011

The value of nothing

Okay, let's pull out the old chestnut: An economist is someone who knows the price of everything and the value of nothing. Right, right, haha, boy you ignorant peasants sure do have a lot of common sense wisdom we lack thanks to years of studying.

Instead of bowing to the inevitability of the low forms of wit, let me argue the point by talking about the Paradox of Value. In the homework for intermediate micro, they are asked about why teachers are paid so much less than basketball players. The "common sense" conclusion is that our society's values are messed up: we value entertainment more than education.

This is nonsense and we've been talking about it since literally Adam Smith.

What were my students asked and what were my answers? Find out below the fold:

a. Suppose we treat our society as a single individual. What is our marginal willingness to pay for a teacher [that is, how much will we spend for the next teacher]? What is our marginal willingness to pay for a star basketball player?

9a: Our marginal willingness to pay foe a teacher is $50,000 and our MWtP for a basketball star is 400 times as much ($20 mil).

b. There are about 4 million teachers that work in primary and secondary schools in the United States. What is the smallest dollar figure that could represent our total willingness to pay for teachers?

B: If we value each teacher at the same amount ($50k), then our total WtP is 4million*50,000 = $200BILLION.

c. Do you think our actual total willingness to pay for teachers is likely to be much greater than that minimum figure? Why or why not?

C: Our actual total WtP is likely much higher. The value of the first few teachers is probably much higher than the value of the teacher we're only barely willing to hire.

d. For purposes of this problem, assume there are 10 star basketball players at any given time. What is the least our total willingness to pay for star basketball players could be?

D: Our least WtP is 10*400mil = 4billion, a small fraction of the WtP for teachers.

e. Is our actual total willingness to pay for basketball players likely to be much higher than this minimum?

E: Probably not. How much more are we willing to pay for the best basketball player as opposed to the 10th best?

f. Do the facts cited at the beginning of this question really warrant the conclusion that we place more value on our entertainment than on the future of our children?

F: This suggests we actually place a much greater value on education than entertainment. It’s just about the value of the marginal teacher and the marginal star basketball player.

g. Adam Smith puzzled over an analogous dilemma: He observed that people were willing to pay exorbitant amounts for diamonds but virtually nothing for water. With water essential for sustaining life and diamonds just items that appeal to our vanity, how could we value diamonds so much more than water? This became known as the [Paradox of Value]. Can you explain the paradox to Smith?

G: The value of the first glass of water is virtually infinite. Once we have taken care of most of our needs, however (drinking, cooking, bathing, washing clothes, swimming in a pool, etc.) the value of one more glass is very low. The value of diamonds by themselves is not very high, but because of an artificial scarcity (we have a lot more diamonds than the companies are allowing to be sold on the market) the marginal value of a diamond is much higher.

Economists understand the value AND the price, and we know what prices communicate about your values too. So there. :)

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