The Online Library of Liberty

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• Foreword
• Preface
• Acknowlegments
• Cost and Choice
• 1.: Cost In Economic Theory
• Classical Economics
• Marginal-utility Economics
• The Marshallian Synthesis
• Frank Knight and American Neoclassical Paradigms
• 2.: The Origins and Development of a London Tradition
• Wicksteed and the Calculus of Choice
• H. J. Davenport
• Knight On Cost As Valuation
• Robbins, 1934
• Mises, Robbins, and Hayek On Calculation In a Socialist Economy
• Hayek, Mises, and Subjectivist Economics
• The Practical Relevance of Opportunity Cost: Coase, 1938
• G. F. Thirlby and “the Ruler”
• Mises’ Human Action
• The Death of a Tradition?
• Appendix to Chapter 2: Shackle On Decision
• 3.: Cost and Choice
• The Predictive Science of Economics
• Cost In the Predictive Theory
• Cost In a Theory of Choice
• Choice-influencing and Choice-influenced Cost
• Opportunity Cost and Real Cost
• The Subjectivity of Sunk Costs
• Cost and Equilibrium
• 4.: The Cost of Public Goods
• The Theory of Tax Incidence
• Costs and Fiscal Decision-making: the Democratic Model
• Costs and Decision-making: the Authoritarian Model
• Costs and Decision-making: Mixed Models
• The Choice Among Projects
• The Costs of Debt-financed Public Goods
• Ricardo’s Equivalence Theorem
• Tax Capitalization
• 5.: Private and Social Cost
• Summary Analysis
• A Closer Look
• Internal Costs, Equilibrium, and Quasi-rents
• An Illustrative Example
• Pigovian Economics and Christian Ethics
• Narrow Self-interest and Alternative-opportunity Quasi-rents
• Conclusion
• 6.: Cost Without Markets
• Prices, Costs, and Market Equilibrium
• Resource-service Prices As Final-product Costs
• Market Equilibrium, Costs, and Quasi-rents
• The Cost of Military Manpower: an Example
• The Cost of Crime: Another Example
• Artificial Choice-making
• Socialist Calculation and Socialist Choice
• Costs In Bureaucratic Choice

Ricardo’s Equivalence Theorem

Ricardo advanced the theorem that a rational person should be indifferent between the levy of an extraordinary tax and the issue of a public loan of equal value. In his model, he assumed that the individual held an infinitely long time horizon and that capital markets were perfect in the sense that the individual could borrow at the same rate as the collectivity. Under such conditions, the individual could without cost transform one of these two fiscal alternatives into the other via transactions in the capital market. It follows that he should be indifferent between them.

As such, the analysis is elementary and obvious. But a similar analysis could be extended to any act of individual choice. If, for example, the individual is informed that he may always exchange one orange for one apple through the market, he will be indifferent between a gift of an orange and an apple because of the possibility of costless transformation. This does not imply, however, that one orange will be equal to one apple in the individual’s subjective evaluation. The latter equality emerges only if the individual is allowed to adjust quantities bought and sold to a point where behavioral equilibrium is fully attained. In isolated, nonequilibrium situations, no such subjective-valuation equality may be presumed. Hence, as applied to the public-loan-taxation alternatives, the individual remains indifferent because he can make the costless transformation, not because the two alternatives are of equal value in his subjective consideration of them.

The recognition of this simple point suggests that the conversion of the public-loan alternative to a present-value equivalent may not accurately measure, or represent, the genuine choice-influencing cost that the debt issue embodies. If the individual is observed to opt for the public-debt alternative, it is an indication that its cost is below that of the tax alternative, which is defined to be equal to the present value of future debt-service and amortization charges. It cannot be inferred that the choice of the individual is marginal. The choice-influencing opportunity costs, the subjective evaluation of the sacrifice of future-period enjoyments, may be substantially below the figure represented by the current capitalized value of the necessary payment obligations. Only if it is presumed that the individual has fully adjusted his spending-saving patterns so as to bring his own rate of time discount into equality with the market rate, can it be alleged that the individual should be on a subjective margin of indifference between the two fiscal instruments. Indeed, it is precisely the differences among the subjective valuations of equal present-value instruments with differing time dimensions that causes the individual to behave so as to move toward full equilibrium. From a methodological point of view, it is surely illegitimate to derive implications for choice among equal present-value instruments, assets or liabilities, from the characteristics of the equilibrium toward which such choice behavior aims.