• Manuel Tacanho

Understanding the Basics of Scarcity and Value

Some people imagine a world where resources are abundant and infinite. A world with unlimited goods, services and resources. Others imagine a world where goods and services are equally distributed among members of society for free.

Well that sounds pretty good. Not a bad scenario to aspire for. But for now let’s focus on reality. And the reality of our existence here on earth is that we must face the fact of scarcity, or limited resource, on a daily basis.

Our human existence is conditioned by the fact that resources are limited and even when easily available, they normally need to be processed or refined for human consumption.

Take the example of water. An indispensable resource for human survival that, to a certain degree, is still pretty much abundantly available. Yet, for proper human consumption, it needs to go through a long and expensive process of retention, treatment and distribution to get to consumers as drinkable water.

This process involves the allocation and coordination of large quantities of various resources. That being said, even water, which seemingly is an abundant resource, is actually still a scare resource.

So when you realize that even potable water is a scarce resource it becomes easier to understand the Great Economic Problem. Which is the problem human societies face of how to make the best use of limited, that is scarce, resources in relation to unlimited needs and wants.

Okay I get it, you might say.

Resources, capital (money), goods and services are inherently scarce. So what?

Being conscious of that will help you make better choices in life and in business for starter. More importantly though, you would be skeptical of government or politician that promises to give this good or that service for free. You would know it is a trap. You would know it is a wolf in sheep clothing.

Because even the mightiest of governments is still constrained by scarcity. But you know how most politicians like to promise free stuff to seduce you and get your vote.

Rest assured, there is no such thing as free lunch, free healthcare services or free education. Because it you’re not paying for it, somebody, somewhen will.

As human beings, we have certain ends, or goals, to achieve with certain available but limited, or scarce, means. This implies choice. We are compelled to choose and prioritize, precisely because resources available to you, me, and just about everyone else is limited.

Well, maybe unless you are Jeff Bezos.

But wait, I mean even if you are Jeff Bezos, the richest person alive, you still face limitations so you have to make choices and prioritize to achieve your goals and satisfy your needs and desires.

In fact, I’ll further add and say that even in our present context of paper currencies, which can be printed out at will (as long as there is ink and paper), governments still cannot escape the natural fact of scarcity. Because a currency that is printed out at will to cover government debt and spending will eventually lose its value through hyperinflation.

The laws of nature do prevail over the laws of men.

That is scarcity, my friend. A natural reality of our world. Even the animals in the forest, the birds in the sky and the fish in the sea face the reality of scarcity, because they too have to hunt (work) to eat and satisfy their needs.

Now let’s turn to the second part the post: VALUE.

Let’s look at it a bit closer, so grab you magnifying glass and let’s dive in.

Suppose a sophisticated computer, let us say a MacBook, costs $1000. This price represents the market value of this computer and it’s fixed by the vender. On the other side are consumers and potential buyers. Logically, people, having individual preferences, wants and priorities will read the $1000 price of this beautiful computer differently.

For instance, a taxi driver, who might be more interested in basic functionalities than style and high performance may consider the price too high to allocate to this computer.

However, for a university graduate, who puts sophistication and high performance above basic computer functionalities, the price of $1000 justifies the quality of the computer, so without further ado, she buys it.

This simple example illustrates that people value things differently, individually and subjectively.

A popular saying goes: “beauty is in the eye of the beholder”… Well, so is value my friend. Go ahead and add that next time.

Value is a big paradox though and people’s valuations of goods and services are, naturally dynamic and evolving.

To explain the paradoxical nature of value economists usually use what is known as the diamond-water paradox.

The Diamond-Water Paradox

At first it seems paradoxical that water, which is indispensable to human life, is incredibly cheaper than diamonds, which are completely dispensable to human survival and healthy living. Again, a key determining factor is scarcity.

Diamonds are a lot scarcier than water.  

The diamond-water paradox, or simply the value paradox, is best understood through the Subjective Theory of Value.

It states that “the value of a good is not determined by any inherent property of the good, nor by the amount of labor required to produce the good, but instead value is determined by the importance an acting individual places on a good for the achievement of their desired ends.”

Today we know that this is true and self-evident. Other thinkings, such as the theory of objective value and the labour theory of value (popular with socialists), have been proven inaccurate and unsound.

Now it is generally understood that the value of a product or service doesn't depend on the inherent properties of the product itself nor does it depend on the amount of labor required to produce it. Rather, it depends on the subjective value individuals perceive in relation to helping them achieve their objectives or satisfy their needs or wants.

So in conclusion, diamonds are a lot more expensive than water, even though water is indispensable for maintaining human life, simply because diamonds are a lot more scarce than water. And because individuals have come to place a high value on diamonds, perhaps because its scarcity, decorative beauty and industrial usage.

However and for the sake of illustration, we could invert the existing scarcity and value relationship between diamond and water by supposing that you got lost in the great Sahara Desert for a few days now and you’ve run out of water.

Then I’d believe that no matter how beautiful the diamond stones may be, faced with a choice, you’d go for water. Presuming you would much rather live than die.

But there is another interesting twist to the value paradox.

In case you chose to drink water, the first glass will give you the most satisfaction, or utility as economists call it, because you are the most thirsty. The second glass of water will still give you enormous satisfaction, but the level of satisfaction, or utility, will tend to decrease with additional glasses of water since now you’re no longer as thirsty as you were when you drank that first glass of water.

That is fundamental characteristic of human nature.

In economics this is called the Law of Diminishing Marginal Utility.

Essentially it states that, all else equal, as additional (marginal) units of a good are consumed the level of satisfaction, or utility, derived from the consumption will tend to decrease, or diminish, proportionally. Hence the phrase diminishing marginal utility.

In conclusion, resources are limited, or scare, and that’s an inescapable fact of nature. Therefore, the great economic challenge is finding the most efficient and productive ways of allocating available resources towards satisfying most pressing needs and wants. To achieve that, the free-market is still the best socioeconomic system for open, free, efficient and productive allocation and coordination of resources, capital, goods and services.

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