*The game referenced in this article is ‘The Tribez‘ offered by Game Insight UAB.
Both Businesses and Economists seek to facilitate more efficient resource management — businesses for greater profitability and economists to increase social welfare.
For economists, meeting the goal of maximizing happiness for society requires the minimization of scarcity — the situation where there are not enough resources for everything society wants to accomplish. We decrease scarcity by improving the way we use manage resources . . . avoiding waste and putting each resource to the best possible use.
In an ideal situation, an economist will identify ways to create new social value for resources we already have (to improve their use) or to create new resources altogether.
To create value, we must know what value is. . .
Value is defined as “what one is willing to sacrifice” to own or possess a resource.
If you are willing to sacrifice $2,000 for a new phone – it’s value (to you) is $2,000.
If you are willing to sacrifice four hours to study for an exam, your grade is valued at four hours time for you.
Let’s say Suzanna has purchased a hut like the one above. In order to do so, she was willing to pay the cost of 20 Food, 20 Lumber, and 3 minutes of labor. Because this is what she was willing to sacrifice — the value of the hut to Suzanna is the total value of her cost (20 Food + 20 Lumber + 3 minutes of labor).
The greater the willingness to sacrifice, the more valuable the desired item. Resources thus have minimal inherent value – they are worth only as much as we desire or need them.
Value is consequently subjective – it depends on the person and circumstances and can be influenced by a variety of factors:
- Limited v. Unlimited Supply
- Other’s interest
Generally, needs are valued above desires and limited over unlimited resources.
The process of creating greater value from the same, original resources is known as Value Creation.
Value creation involves transforming or combining resources to create something more valuable to society than the original inputs. E.g. consumers generally value a finished product more than the individual components.
There are three primary strategies for economic value creation: Manufacturing, Trade, and Marketing
Value can be created when a resource is transformed through physical modification or through combination with another resource.
In the first situation, an otherwise less valuable raw material is modified in shape or nature such that it becomes more useful.
- Transforming raw copper into copper wires.
- Transforming wood into lumber.
- Transforming sand into glass.
- Recycling trash into a new product
In the second instance, otherwise less valuable raw materials are combined to create a new, more valuable result.
- Combining water and flour to create pie dough.
- Combining blue paint and red paint to create purple paint.
- Combining Coca Cola with plastic bottles to create a transportable drink.
- Combining metal and parts to create a car.
Consider the following:
Jane, a electronics manufacturer has purchased raw copper from a supplier for $250.00.
Jane also invested $10.00 in labor and equipment.
Before manufacturing: the raw materials are worth $260.00.
Jane then combines the components to create finished copper wire for use in her electronic products. This copper wire is worth about $400.00 in the current market. Jane has transformed $260.00 worth of materials into something worth $400.00.
How much value has Jane created through manufacturing?
$400.00 (end value) – $260.00 (beginning value) = $140.00 value created.
Value can also be created when two resources less valuable to their present owners are traded such that both owners become more satisfied than before.
The simplest example is where Jackie has strawberry ice cream, but wants chocolate. Timmy has chocolate ice cream, but wants strawberry.
At present the chocolate ice cream and strawberry ice cream are worthless as they are in the hands of those who don’t want them.
Jackie and Timmy trade ice cream cones such that each is satisfied with what he has. With this trade, the chocolate and strawberry cones have increased in value by shifting to the hands of those who value them more.
This kind of value creation is mutual – both parties see value creation.
Business is fundamentally a value-creation process. Sellers trade products for the money they prefer; while buyers trade money for products. In this way, both are ideally more satisfied after trade than before.
Consider the Following:
Jane has finished developing a computer with an overall production cost of $1,000.00. The current value of the computer (to Jane) is thus $1,000.00 (what she sacrificed). Of course Jane is not truly interested in the computer – she’s looking for money which she values more.
Michael has $1,700.00 burning a hole in his pocket. He sees the computer and is willing to pay $1,600.00 maximum for it. They negotiate, and Michael agrees to pay Jane $1,400.00.
Jane created value by transforming a $1,000.00 computer into $1,400.00 in cash. Value Created = $400.00
Michael believes the computer is worth $1,600.00 (remember he was willing to pay this much). He only paid $1,400.00. Consequently, Michael has transformed $1,400.00 cash into a computer worth $1,600.00. Value Created = $200.00.
Many companies seek to create value not by altering the product itself, but by changing the customers’ perception. This can be done in a variety of ways:
- Explaining the benefits to a customer who previously was unfamiliar.
- Creating an impression of popularity by having celebrities demonstrate it.
- By creating the impression that this product is unique and limited
- By creating an ethical element (buy this product and help a single mother keep her job).
Because value is subjective, it can change with a strong marketing strategy.
The Importance of Value Creation
If Jane believes her computer is worth $1,500.00 and Michael is only willing to pay $1,400.00, trade is unlikely. Note that Jane and Michael will only trade where each believes he/she is better off with trade than without.
Thus, value creation is fundamental to the practice of trade and thus business entirely.
The Mansion is nice and generates 400 coins in rent. It is rather cheap (gold, food, and stone are easy to produce), and most players have purchased several such homes.
Conversely, the Antique House creates only an additional 100 coins (500 coins total) but costs 45 diamonds — extremely difficult to find (usually only when advancing a level). Diamonds have classically been so difficult to find that players value them more than the antique home. Thus not every player invests in the antique house.
What if Value Creation is Impossible?
Where value creation is not possible there are two alternative ways to improve resource management.
1) Cost Minimization – If one cannot increase the value of a resource, perhaps there are ways to minimize the cost / decrease the sacrifice required. Thus customers who were unwilling to pay the current sacrifice can now access a larger variety of resources.
2) Value Capturing – Occurs where one party takes value that belonged to someone else. This is less ideal because it does not improve society, rather it simply shifts resources from A to B. It may however be a good strategy for improving social or selfish interests where one party’s benefit is preferred.
The Math Behind The Trade
Sometimes, trade and value created are expressed in mathematical terms:
- Positive Sum → The situation where value is created for both parties in trade. → Win + Win = +
- Zero Sum → The situation where value is created for only one party in trade or where neither party benefits or loses value → Win + Lose = 0
- Negative Sum → The situation where value is lost for both parties in trade → Lose + Lose = –
|Value||What one is willing to sacrifice to own or possess a resource|
|Value Creation||The process of creating new, greater value with the same resource|
|Value Destruction||To transform a resource into something less valuable|
|Value Capturing||To take value held by someone else for your own.|
|Positive Sum||Trade wherein both parties are more satisfied than before. Win-Win. Results in value creation|
|Zero Sum||Trade wherein one party is more satisfied, but the other party is not or where neither party is satisfied or dissatisfied. Win – Lose. Results in value capturing|
|Negative Sum||Trade wherein neither party is more satisfied. Lose-Lose. May result in value destruction.|
|Subjective||To be changeable, depending on the thoughts, beliefs, and ideas of the person.|
|Mutual||Occurs to both parties or is done by both parties at the same time.|