Explaining the Measures of Worth
Lawrence H. Officer and Samuel H. Williamson
Clearly, intrinsic values, objects, and events are difficult, if not impossible, to measure in money terms. There is probably no objective way of assessing the worth of freedom of speech, good health, or a beautiful sunset. Such items lack a well-defined monetary amount associated with them. Therefore we do not attempt to measure the worth of such things.
We also cannot measure the worth even of an item associated with a money amount, if the time period (say, year) of that money amount is not clearly established. What is the worth today of "a loaf of bread produced or consumed sometime in the past"? Such an incompletely phrased question cannot be answered.
We are concerned with measuring the worth of items with which both a monetary value and a past time period are clearly associated. For example, A loaf of bread sold for seven pennies in 1915; what is its "value" today? Your great-grandfather's estate was $1000 or Ј200 in 1900; what is that worth today?
Undoubtedly, the worth of such monetary amounts is also difficult to measure. However, as long as a purchase, wage, or any transaction, or wealth or other asset, has an associated monetary amount and date recorded, there is hope.
In most cases, if the transaction takes place today or the asset is in existence today, and if the money amount involved is in a range with which we are accustomed, then this discussion is considered trivial. In that case, we consciously or subconsciously compare the transaction or asset amount with similar transactions or assets. This is an application of what economists call "opportunity cost." For example, the Ј10 or $20 that one pays for a hardcover book is "worth" any one of a multitude of other things that we know costs the same amount, be it a DVD, nice bottle of wine, or a clock radio.
When the transaction or asset is not in a range with which we are familiar, such as 100 million dollars or pounds, or if the transaction or asset occurred or existed at a time different from the one in which we live or can remember, it is much harder to "know" the comparisons. There is yet another problem: one person's "comparison" could be quite different from that of another person. The worth of a certain amount of money, sufficient to buy enough macaroni and cheese to last a week for a very poor person, could be merely a tip to a doorman for a wealthy one.
The technique we use is to apply alternative monetary scales or indicators from the desired (later or present) year to an item in the initial (past) year. The result (for each alternative) is a value that has been adjusted (usually increased) by the growth in the indicator. This is the meaning of relative worth over time. Always remember that it is the item in the initial year for which the relative value is calculated. Even if
that item, or something comparable to it, may not exist in the desired year, the relative worth of the past item is still computable.
Because of these issues, we have created a set of "measures of worth" that depend on two factors: (1) the type of transaction or asset, called the "subject" and (2) the appropriate comparable, called the "indicator." Which measure (that is, which of the alternative results) is best depends on a proper identification of both the subject and the indicator.
While there can be a large number of indicators, we present six common ones here, which can be classified into four types.
1. Prices. There are two general price indicators used here: the consumer price index (CPI) and the gross domestic product (GDP) deflator. The CPI, or the retail price index (RPI), involves a bundle of commodities confined to consumer goods and services. This bundle is a fixed amount of food, housing, clothing, entertainment, etc. that is proportional to what the average household consumes. The GDP deflator involves a bundle of commodities that incorporates all output in the economy, including consumer goods and services, investment goods, and government-provided goods and services.
The CPI or RPI is obtained by constructing an index-number, based on surveys of household expenditures and prices of consumer items. The GDP deflator is computed as the ratio of nominal GDP to real GDP. The CPI, RPI, and GDP deflator increase over time, in line with inflation.
2. Household Consumption. The CPI measures the cost of a fixed bundle of household consumption. However, over time, incomes grow, and the amount households spend increases. The Value of the Household Bundle (VHB) is the measure of the total amount that the average household spends on goods and services in a given year. Over time this indicator increases for two reasons: households both purchase more consumables (higher standard of living), and the prices of consumables increases (inflation).
3. Income. There are two income indicators: the wage and per-capita GDP. Wage is compensation for labor. Per-capita GDP is economy-wide total output divided by population. Because only part of output goes to labor, per-capita GDP is generally larger than average wage.
4. Output. The total output of an economy is measured by the Gross Domestic Product (GDP), the market value of all goods and services produced in a year.
There are three classes of subjects:
A. Commodity. A good or service, usually purchased by a consumer. This category includes items such as bread, a restaurant meal, an automobile, a tax paid, or a charitable contribution.
B. Income or Wealth. A flow of income (wages, profits, interest, rent) or wealth (a financial or real asset or liability).
C. Project. A business or government investment (such as construction of a canal or installation of a cable network) or a government expenditure (such as financing social security or a war). Certain consumer or non-profit expenditures, such as the creation of a charitable foundation, can also be defined as a project.