Stigler Chapter 4: The Theory of Utility Part 2

Stigler spends a long time developing utility theory. He claims that abstract utility with its questionable foundation is a useful tool, because of its predictive power. Though the foundations are not great, the results justify it. Stigler spends the rest of chapter four showing off the power of utility theory.

Consumer Behavior

In order to test the predictive power, we obviously need to make some predictions from our model of utility maximization. Stigler sticks to mostly graphical predictions that involve reaching the highest indifference curve that is still within the consumer's budget. The graphs allow economists to do comparative statics. If one aspect changes, how does that affect the consumer's bundle?

One type of change is variations of income. On a graph, this corresponds to a shift of the budget, illustrated below. Normally, when people are richer they consumer more of a good, hence normal goods. Other times, when a consumer is richer, he consumes less of this good. The classic examples are ramen and potatoes. As college graduates start making money, ramen consumption declines. These are inferior goods.

While not a formal prediction, the outline of utility theory's predictive power is starting to form. This model of normal and inferior goods suggests which types of goods will increase with wealth. Inferior goods convey the idea of "buying because it is cheap." This is simply a definition, but it clarifies the thinking. Continue reading

Stigler Chapter 4: The Theory of Utility Part 1

In similar fashion to Mas-Colell, Stigler is creating a dual theory. One side is producer theory, which describes behavior under the goal of profit maximization. The other side is consumer theory, which describes behavior under the goal of utility maximization.

Utils

Profit maximization has a clear meaning, at least from an accountant. Utility maximization is more complex. What the heck is a util? "The answer- that a util is a unit of utility- itself has zero utility" (Page 43) Why would someone maximize it? Utils, and utility theory, is an attempted to reduce enjoyment/pleasure/happiness/utility down to one value. More utils means the person is happier.

Utility theory came into economics in the 19th century through psychological explanations. Starting with their godfather, Jeremy Bentham, these theorists saw human behavior as a product of increasing pleasure and decreasing pain. The net of this would be a person's utils. This psychological theory reaches its pinnacle with the work of Francis Edgeworth's Mathematical Psychics. (While this might be the best book title ever, most economists only remember Edgeworth for his famous box.)

This theory fell apart over time. Stigler claims economics has abandoned this simple calculus and

The simple measure of utility, the comparisons of utilities derived by different people, the use of interpersonal utility comparisons to support public policy proposals- all were gradually abandoned in part or in whole. What was retained was the concept of what we may term a rational consumer. Pg 43 Continue reading