Monday, October 27, 2008

Psychic Impairment

My latest post on the Blog at

Psychic Impairment

Jim Fedako

Last week wmtbsX.gif
I suffered a psychic loss in the form of a goodwill impairment charge. What?!? Only the business firms take goodwill charges. Not so fast. While it is true that firms take such charges, it is also true that everyone experiences psychic profits and losses throughout the day.

Acting man seeks to increase the asset side of his psychic value in every exchange; he seeks psychic profit. However, just as in a free market, losses are everywhere. And it's our value judgments of potential psychic profits and losses, and our value judgments alone, that have the ability to guide an economy toward an efficient utilization of scarce resources.

Unlike other schools of economic thought, the Austrians do not construct homo economicus as the originator of action. In its place, the Austrians assume a myriad of acting individuals, all basing their actions on purely subjective valuations. The key here is that acting man can change his valuations at any point, based on purely subjective reasoning.

I have a used car that I value more than the market price as noted by Kelley Blue Book, etc.[1] This is an apodictically true statement since I still possess my car, in spite of the market price. By way of an example, let's assume that KBB notes the market value of my car at $10,000. From the above, we know that I value the car at some price greater than $10,000. I call the difference between the KBB value and my subjective value goodwill. But what is goodwill?

Goodwill is an accounting term that describes (generally) an intangible asset. An example is a brand name that raises the value of a company over that of its underlying assets. Therefore, when you buy (say) PepsiCo, you buy the intangible value of the brand name Pepsi along with the company's bottling plants, etc. The same holds for our personal possessions -- we assign value that exceeds the market price.

If a month ago I had constructed a psychic balance sheet of my personal assets and liabilities, I would have recorded my car at some value greater than $10,000 -- say $15,000. I would have noted the difference between my subjective value of $15,000 and the market value of $10,000 as goodwill.

To me, the goodwill value existed because I know (inter alia) the history of my vehicle -- I know my car's repair and maintenance histories, etc. I saw no value in trying to find arbitrage opportunities by trading my car for a similar one. So, if presented with an equal exchange between my car and one with (say) 10,000 less miles and a slightly higher KBB value, I would have said no. That all changed last week.

There I sat in downtown Delaware, Ohio in a car that would not start. After a tow to my local garage, I learned that the fuel pump needed to be replaced - $700 out the door. So I took a hit against cash and I recorded a large goodwill write-down. Why the write-down? I no longer consider my car to be a trusted vehicle. It is impaired, and so is my psychic balance sheet. Gone are almost $5,000 in psychic value, just like that. Of course, I say almost because I am still not willing to sell, though I am considering.

The point is that subjective values are subjective, and they are subject to change the first time the engine does not turn over.

The same can be said of preference ranks. These purely subjective rankings can change within seconds. Consider this: All morning at work you've dreamed of the Big Mac. Come lunchtime, you grab your keys and head to the parking lot. On your way out the door, a coworker asks you where you are going - McDonalds, of course.

In essence, you are stating that the Big Mac holds the highest position on your lunchtime preference ranking. Yet, once on the road, the Whopper sign catches your eye. Hmmm. Now the Whopper was near the bottom of the ranking, but in less than a second the Whopper shoots straight to number one. You turn into Burger King and enjoy your meal, satisfied.

To assume homo economicus as the acting agent in all activities, and then build models with indifference curves, etc., does nothing to advance knowledge. Individual actions are the result of subjective valuations that are themselves changing. The time spent constructing the car versus Big Mac indifference curve is exposed as a waste once the key fails or the Whopper appears.

The subjective valuations that guide human activity are much too complex to be modeled in a manner that explains or predicts anything with certainty. The beauty of the Austrian approach is that it allows us all to be our fickle and erratic selves. Moreover, by doing so, the Austrian school reveals the truths of the science of human action. And in our current financial crisis, we need to hear those truths again and again, loud and clear.

Jim Fedako, a homeschooling father of six who lives in Lewis Center, OH, maintains a blog: Anti-Positivist.


[1] Of course, the market price can only be determined by an exchange between freely acting participants.

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