Consider the problem facing Reginald Buford, an aspiring kumquat farmer. From 6 in the morning to 2 in the afternoon Reginald delivers mail for the U.S. Postal Service in Lodi, California. Reginald is an ambitious kind of guy, and he hears there's money to be made growing kumquats. He figures he could grow a 1000 bushels of kumquats a year on an acre of land working afternoons and evenings after delivering his mail. From reading the Wall Street Journal that he delivers to one of the houses on his route, Reginald learns that kumquats are selling for about $43/bushel. How much would he be willing to pay to rent an acre of land for a year?

Let's assume that all it takes to grow kumquats is an acre of land and Mr. Buford's good labor--nothing else. At $43/bushel and 1000 bushels a year, Reginald calculates he can make $43,000 a year. Since the only inputs to producing kumquats are land and labor, and the labor is "free," you might be tempted to say Reginald Buford would be willing to pay up to $43,000 to rent an acre of land on which to grow kumquats. But since you're smarter than the average reader, you realize that it isn't quite this simple. While Reginald's labor does not cost him anything, it's not as though he doesn't have anything better to do with his time. If he wasn't raising kumquats, Reginald would be sipping margaritas on the deck of his backyard, above-ground pool, working on his tan and keeping an appreciative eye on his next door neighbor, Bambi Vavoom (but that's another story).

In fact, Reginald's labor does cost him something. It costs him the happiness he would receive from what he would be doing if he wasn't raising kumquats. As a result, Reginald figures that he needs to make at least $20,000 a year in income from his kumquat venture. Anything less than that wouldn't be enough to compensate him for the time he is giving up. As a result, Reginald Buford is willing to pay up to $23,000 a year for his acre of land. ($43,000 in revenue from kumquats minus $20,000 for Reginald's lost leisure time yields a $23,000 willingness to pay valuation of the land. In other words, if the land costs $23,000 to rent, the $43,000 of revenue will just cover rent and the dollar value of Reginald's lost leisure time.)

What would happen if Reginald paid more than $23,000 a year for the land? Suppose he paid $30,000? Then, at the end of the year--after he grew and sold his 1000 bushels of kumquats--he would gross $43,000 in income. From this he would have to pay $30,000 in costs for his acre of land, leaving Reginald with just $13,000 in net income. Now $13,000 might sound like plenty of money to you, but it's not enough for Reginald Buford of Lodi, California. He would have to make at least $20,000 to get him to give up his current lifestyle and go into kumquat farming. That is why he wouldn't be willing to pay $30,000 a year for the land. Indeed, that is why he wouldn't be willing to pay anything more than $23,000 a year for his acre of land.

The world is full of Reginald Bufords. Some want to go into kumquat farming. Others want to raise oranges, peaches, squash, and kiwi fruit. Others want to expand their current scales of production. For example, just a mile down the road from Mr. Buford is Sally Raisin, of the California Raisins. Sally currently owns a 100 acres of farmland on which she grows grapes. She is thinking of renting an additional acre in order to increase her grape production. Let's assume that all it takes to grow grapes is an acre of land and Sally's good labor--nothing else (remember, this is not a textbook on how to farm!). Further, let's say that the market price of grapes is $38/bushel, and that Sally Raisin could grow 1000 bushels of grapes on an acre of land in a year. How much would Mrs. Raisin be willing to pay for this land?

Once again, we have to consider the value of her time. Having an extra acre of land means more work for Sally Raisin, and less time at home with her husband and kids. As a result, Sally figures she'd have to make at least $15,000 a year in take-home income to compensate her for the extra hours she'd be spending away from her family. Subtracting this from the $38,000 in sales revenue that she would make from the extra 1000 bushels of grapes she would grow, Sally Raisin calculates that she also would willing to pay up to $23,000 a year for the acre of land.

Of course, the fact that Reginald Buford and Sally Raisin both are willing to pay the same amount for an acre of land is a coincidence. Other farmers, and aspiring farmers, will have different willingness to pay values: $13,000 an acre; $29,000 an acre; $18,000; etc. In fact, there are thousands of farmers out there, each with their own particular willingness to pay value. In this respect, input goods are just like the output goods we discussed earlier.

Now suppose we had some way of producing an additional acre of farmland in northern California's Napa Valley--say, by reclaiming land that had previously been wiped out in a mud slide, or brush fire, or earthquake (take your pick). Suppose further that the market rental price of an acre of farmland in the Napa Valley was $23,000. Some farmer is going to end up with an acre of land that he wouldn't have had if this extra acre of land had not become available. This is the marginal farmer. What do we know about the willingness to pay value of the marginal farmer?

Is the marginal farmers' willingness to pay value going to be a lot larger than $23,000? By no means. Why not? A farmer who valued an acre of land a lot more than $23,000 would be sure to get an acre of land whether or not an extra acre was supplied to the market (does this sound familiar?). Is the marginal farmer's willingness to pay value going to be a lot less than $23,000? Of course not. Even with an extra acre of land, the market price of land in the Napa Valley will still be about $23,000. That means the marginal farmer will have to shell out around $23,000 in cold, hard cash to get this acre for a year. He certainly would not be willing to do this if he had a willingness to pay value that was much less than $23,000. Thus, the farmer who ends up with the extra acre of land must have a willingness to pay value for land right around $23,000-- not a lot more, not a lot less. Just as in the case of output goods, the marginal purchaser of the land has a willingness to pay value right around the price.

What has happened to society's happiness now that an extra acre of land has become available? The correct answer is...we can't say! We can't say at this point because--note--the farmer who uses the land does not get any direct pleasure from it. The farmland is an input. It is being used to produce other things that provide happiness, but it doesn't provide happiness on its own. Thus, we can't just assume that the farmer's willingness to pay provides a measure of happiness. This will turn out to be the case, but we have to prove it first.

To trace out the effect on society's happiness, we have to follow through all the consequences of employing the farmland that impact society's happiness--remembering that society only gets pleasure from output goods. Let's return to our aspiring kumquat farmer, Reginald Buford. Suppose as a result of having an extra acre of land in the Napa Valley, Mr. Buford is the marginal farmer who ends up having an acre of land which he would not have had otherwise. On this acre of land, Mr. Buford grows 1000 bushels of kumquats, and kumquats sell for about $43 a bushel How much happiness has Mr. Buford produced by growing kumquats? $43,000. Kumquats are an output good. If the price of kumquats is $43/bushel, we know from our previous analysis that an extra bushel of kumquats would yield about $43 in happiness. An extra 1000 bushels would yield about $43,000 in happiness. Thus, having an extra acre of land has caused society to have $43,000 in happiness from eating kumquats that it would not have had otherwise.

But there is a downside to all this happiness. In order to produce these kumquats, Reginald Buford had to give up those leisurely times of sipping margaritas, working on his tan, and admiring the handsome Bambi Vavoom. This loss in leisure means that Reginald missed out on $20,000 in happiness over the course of a year. A social accounting shows that society gained $43,000 from the kumquats (an output good), but lost $20,000 from Reginald's leisure time (also an output good). As a result, employing the extra acre of land resulted in a net gain to society's happiness of $23,000. Not coincidentally, $23,000 also happened to be Reginald Buford's willingness to pay for the land...and the price. This demonstrates our claim: THE PRICE OF AN INPUT GOOD IDENTIFIES THE GAIN IN HAPPINESS--MEASURED IN DOLLARS--THAT SOCIETY RECEIVES FROM EMPLOYING ONE MORE UNIT OF THE INPUT GOOD.

By now you should have no problem telling the story in reverse, about the loss in society's happiness from having one less unit of the input good. That is, you should be able to easily demonstrate that THE PRICE OF AN INPUT GOOD ALSO IDENTIFIES THE LOSS IN HAPPINESS--MEASURED IN DOLLARS--THAT SOCIETY RECEIVES FROM EMPLOYING ONE LESS UNIT OF THE INPUT GOOD.

This is important stuff. If we know that the rental price of land is $23,000 an acre for a year, and if some reason society were to lose the use of this land, society would suffer a loss in happiness of approximately $23,000. We can say this without even knowing what that land was going to be used for. Maybe Reginald Buford would have used it to farm kumquats. Maybe Sally Raisin would have grown grapes on it. Maybe some developer would have built luxury condominiums on it. Perhaps the land will be used for a new factory. It doesn't matter what is done with the land. All the information that we need to know is right there in the price. And while we've told this input story about an acre of farmland, it should be clear that the story is valid for any of the innumerable different types of inputs that are used to produce output goods: a ton of steel, a truck, a gallon of water, a shovel, an office personal computer, a kilowatt of electricity, a 5000 square foot warehouse.