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Why Austrian School Economists Have a Better Understanding of Goods and Services

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Tags Austrian Economics OverviewOther Schools of ThoughtValue and Exchange

10/24/2019

There is a lot of confusion about the concept of a “good” in economics.

While thinking of goods as products (or services) is an easy shorthand, it doesn't quite capture economic reality. And it induces logical mistakes and outright errors. Economics is not primarily about physical reality, but about the use of it from the perspective of human wants.

In other words, it matters little whether a thing is a thing. What matters is if that thing can be used toward some valued end, and then if this use is an economizing use. What makes a good a good is not its physical properties, but the value we find in it because it is serviceable toward some valued end.

There are plenty of things that are not goods because they are either not scarce (so we do not need to economize them) or not useful. Oil was an utterly useless thing before the innovation of refined petroleum and the internal combustion engine. It did not become a good until after those innovations, but it certainly did exist in physical reality.

So why does this matter? It is fundamental to not make mistakes in one's understanding of economics and society.

Non-Austrians tend to make such mistakes because they are not carefully thinking about things. Examples of mistakes include so-called Giffen or Veblen goods, which supposedly disprove (or at least contradict) the law of demand.

Giffen goods are those that consumed more when the price goes up (and vice versa).

Veblen goods are basically the same thing, but only for conspicuous luxury items.

These are curious examples that raise many questions. But they are really just misunderstandings. There are no exceptions to the law of demand, and that includes Giffen and Veblen goods. The problem is that if a good is a good by virtue of it being valuable toward some end, what defines the good is not the physical composition of it, but the use-value.

It is easier to think of a car as a car, but we don't actually want a box of steel with four wheels and an engine, but the services it offers: transportation, freedom, status, whatever. What makes it a good in our eyes is the use-value, and it may be different for different people.

It also does not follow that what we call a car must be the same good: people buy Fords and Lamborghinis for very different reasons and purposes. Are they the same goods? They certainly are both "cars,", but few buyers of Lamborghinis would consider buying several Fords for the same sum of money. Why? Because they get something different out of the Lamborghini than the Ford.

It is a different good to them.

The same applies to an identical physical product at different prices, because the perception is different. A Veblen good, which people consume more of when prices rise, is not a contradiction unless one looks only primarily at the physical composition of it. But in any market, positioning a good as premium rather than run-of-the-mill could increase demand.

Apple products are good examples: there is little reason to assume the technical capabilities of the iPhone is the reason people buy lots of iPhones at rather ridiculous prices.

The reason we pay more (and thus Apple sell more of their comparatively higher-priced phones) is that the iPhone is not considered a standard smartphone. It is a different good than a comparably capable smartphone from another manufacturer.

Many consumers consider iPhones incomparable to other smartphones that are technologically, physically, etc. almost identical goods, and thus are willing to pay a higher price. Having an iPhone signals status and provides users with many other benefits that other manufacturers of smartphones cannot compete with because their smartphones constitute different goods in the minds of consumers.

Would this be the case if Apple lowered the price? Hardly!

The iPhone is considered the 'gold standard' of smartphones because it is a premium product, not because of its technology. And Apple cannot maintain its premium branding at a lower price: the high price is part of the good!

If the iPhone 11 would sell at $500, the 'preminumness' would soon wear off and Apple would lose its market share. That's how Veblen goods work: because of their premium/luxury/signaling positioning in the minds of consumers, they are highly cherished. But they would be less valued without this 'quality', so they would be different goods to consumers.

This is not a paradox or curiosity that we can't explain using standard economic theory, but rather the opposite: we find these things curious because we have deviated from the theory.

Giffen and Veblen goods appear strange and even contradictory to the law of demand because we have, perhaps unbeknownst to us, moved from considering economic goods to instead look at the physical products. But this means we're in the realm of technology, engineering, physics, etc.--but not economics.

We're consequently subjecting the law of demand to a test that is irrelevant because we've misconstrued the test case: the good as a non-economic good.

What we're dealing with here is only a poor application of economic theory, based on a misunderstanding of what makes an economic good. The curiosity of Giffen and Veblen goods is not that they appear to contradict the law of demand--which they do not--but why economists, who should know better, fail to properly understand the very fundamental concept of an economic good.

The Pet Rock, for instance, was a good not in virtue of being a rock (rocks don't generally sell at a price), but in virtue of being positioned in the market, in the minds of consumers, as a pet-as-a-joke. No one would think the Pet Rock is like any rock, but with upward-sloping demand curve. Yet they do the very same thing with luxury cars.

It's simply poor economics.

It is a shame economists keep fooling themselves and repeating the error. 

Formatted from Twitter @PerBylund

Per Bylund is assistant professor of entrepreneurship & Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma State University. Website: PerBylund.com.

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