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

Mas-Colell Chapter 3: Classical Demand Theory Part 1

In economics, it is common to say that people maximize their happiness. What does that mean? How can we develop a model for maximizing happiness?

While chapter 2 focuses on choice rules as the basis for a theory of the consumer, chapter 3 returns to preferences. From these preferences, MWG develops a theory of consumer demand. Much of this chapter reiterates the first chapter. Part of this post will look familiar.

Axioms and Assumptions

MWG assumes rational preferences. Rational preferences must be complete and transitive. Chapter 1 explained these. They are central to microeconomics.

In addition to the axioms, which can never be violated in this analysis, MWG adds more assumptions. They may not always hold in reality or be used in every model, but simply the model. This is always the trade-off.

Desirability-

Consumers always want more. They never have "enough". While these seems silly, at some point I have had enough ice cream and become sick, MWG extends the time-frame. 2 gallons are too much for today, but not for a year. This is different from Rothbard, who looks at specific action at a specific time.

Also, MWG is only looking at goods. Everything consumed is desirable. Bads, such as pollution, become goods simply by reframing the problem. Consumers might not want more pollution, but they can want more clean air. Here the good is clean air. This change does not affect the fundamental nature of the problem.

Convexity-

Throughout this chapter, MWG assumes that preferences are convex. Convexity is a mathematical term, but has an economic interpretation.  As the consumer receives more of a good, say apples, he will want each additional unit less than the previous, relative to other goods. This makes sense in most cases. This formulates "a basic inclination of economics agents for diversification." This is the diminishing marginal rate of substitution. 

It is a little disappointing that assumptions so central to the analysis of demand are just that, assumptions. Yes,they are realistic in most cases, but not always. The student of methodology in me is saddened. Nevertheless, the analysis trots on.

Preference and Utility

We use these assumptions to construct a utility function. With a utility function, MWG can turn economics into calculus. However, even the assumptions made so far are not enough. One more in needed. Continue reading