Saw this statement the other day in a post by Mishedlo, “You can ‘value’ your home for whatever price you want. But the market is the arbiter of value”, which was then followed in a subsequent post by, ”value should reasonably converge with price on most assets,” and thought it might be worthwhile to expand a bit on the relationship between market prices and value.
Without going into fine detail, it is usually assumed that the value of a good is subjective, meaning that each individual assigns a personal value to each good. Theoretically, we can determine this value by finding the maximum amount of other goods (e.g. money) an individual would be willing “pay” to acquire the good, and this amount is known as the “Reservation Price” of that good for this particular consumer. More succinctly, the reservation price of a good represents the value assigned by an individual to that good. There is also a reservation price that applies to sellers, which corresponds to the minimum amount a seller will accept, and similarly represents the subjective value assigned by the seller to a good they supply/produce.
Now, a market is nothing more than an aggregation of consumers and suppliers. The aggregation of consumer reservation prices constitutes the market demand curve and the aggregation of supplier reservation prices constitutes the market supply curve. From Econ1A we know that the market-clearing price of a good occurs at the intersection of the demand and supply curves, which obviously occurs at a single point - a single price. Consequently, how could the market price of a good ever equal the value assigned to that good by every individual seller and consumer when it is the curves that represent those values? It can’t, of course.
We can, without reservation, assert that the market is the arbiter of prices, not value. And while it’s never our goal to embarrass anyone, it is fair to say that Mish’s statement reveals a fundamental defect in his understanding of the economic process, one that surprisingly isn’t confined to Mish, but also appears in the writings of John P. Hussman, Ph.D (Econ), of Hussman funds. Hussman's error will be the subject of a later post, and reviewing it should be worthwhile.
Mish’s original post: Message 22551398 |
