Why Prefer Preferences?

Nick Rowe offers a summary of the Cambridge Capital Controversies that, though it is tongue in cheek and should not be taken too seriously, substantively leaves a lot to be desired. He states that the debate started because “some economists in Cambridge UK wanted to explain prices without talking about preferences.” This is false – the debate started because Joan Robinson and Piero Sraffa took issue with a production function that used an aggregate capital stock k, measured in £, with a marginal productivity. However, despite the faulty summary of the controversies, and to Rowe’s credit, some good discussion followed in the comments.

Sraffa built up an entire model just to critique neoclassical theory. It followed neoclassical logic, but replaced the popular measure of capital with a more consistent one: summing up the labour required to produce it, and the profit made from it. His model of capitalism started with simplistic assumptions, but increased in complexity. Within the confines of his own model, he showed several things: the distribution between wages and profits must be known before prices can be calculated; demand and supply are not an adequate explanation of prices, and the rate of interest can have non-linear effects on the nature of production. I cover this in more detail here.

Rowe’s primary criticism of Sraffa is that his model did not use preferences, which is a criticism also made by others.  But eliminating preferences is a neglibility assumption: we ignore some element of the system we are studying, in the hope that we can either add it later, or it is empirically negligible. As Matias Vernengo notes in the comments, Sraffa was deliberately trying to escape the subjective utility base of neoclassical economics in favour of the classical tradition of social and institutional norms, so he assumed preferences were given. This is just a ceteris paribus assumption, which economists usually love! In any case it turns out that preferences can be added to a Sraffian model, with many of the key insights still remaining. Indeed Vienneau’s model (and, apparently, the work of Ian Steedman, with whom I am unfamiliar) invoke utility maximisation and come to many of the same Sraffian conclusions about demand-supply being unjustified.

Rowe also criticises Sraffa’s approach because it puts production first, over the consumer sovereignty upon which neoclassical economics is built. Should preferences provide an explanation of decisions? It appears Rowe does not take seriously the ‘chicken and egg’ problem with neoclassical models – surely, production must occur first, yet models such as Arrow-Debreu take prices as a given for firms, before anything is made.

In a modern capitalist economy, it seems illogical to say that the demand for a particular good comes first, then the supply follows as firms passively try to accommodate it. If it were true, advertising wouldn’t exist, or would be incredibly limited. It is fair to say that, independently, people have a ‘preference’ (though I’d say instinct) for food, shelter, clothing, security and other creature comforts. However, demand for most goods and services beyond this is certainly generated by advertising, marketing and other exogenous factors – advertising and marketing are one of the two primary expansion constraints experienced by real world firms (the other is financing, which, incidentally, neoclassical models often assume away too, but I digress).

An alternative way to model human behaviour would be an institutional/social norm perspective: while people instinctively want to subsist, what exactly they choose to subsist on is in large part dependent on their surroundings. There is the example of tea consumption in Britain, which started as a luxury and took decades to filter down to the lower classes. Similarly, if I had been born in India, I would probably have more of a taste for spicy foods. It’s hard to deny these things are largely dependent on social surroundings, rather than individualistic consumer preferences. Similarly, Rowe’s focus on the time-preference explanation of the interest rate seems to ignore that this will be largely dependent on institutional factors such as the state of the economy.

From an individual perspective, perhaps Maslow’s Hierarachy is a useful way of understanding purchasing decisions: after people have obtained basic needs such as food and security, things they buy are to do with identity and emotion. Don’t believe me? These concepts are exactly what firms use to try to expand their market base (for a longer treatment, see Adam Curtis’ documentary). If people don’t buy products because firms associate them with ‘self actualisation,’ then firms are systemically irrational.

Overall, I don’t think there are there any cases in which we can evaluate individual’s preferences outside a social and institutional context. Sraffa considers the economy as a whole, and leaves subsequent questions about consumers to be answered later – which they have been. Conversely, putting preferences first and having firms passively accommodate their demand runs into several logical problems, and does not corroborate with what we know about both firms and people in the real world.

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  1. #1 by J St. Clair on September 13, 2012 - 5:30 pm

    hence…entertainment industry role…..mass media advertising…..

  2. #2 by J St. Clair on September 13, 2012 - 5:31 pm

    thats why society as a whole is degenerating

  3. #3 by ivansml on September 13, 2012 - 7:30 pm

    In popular discussions on economics one event is represented as determining a second, which determines a third, which determines a fourth, and so on. Reasoning of this kind can be followed without effort by anyone; but it does not correspond to the facts of nature and has been the source of much confusion. In human conduct one condition does not control another, but altogether they mutually determine one another. To grasp at one view this manifold mutual action is a very difficult task. – Alfred Marshall: The present position of economics

    • #4 by Unlearningecon on September 14, 2012 - 4:30 pm

      We are in agreement.

      • #5 by ivansml on September 14, 2012 - 4:53 pm

        Then you shouldn’t write stuff like this:

        “It appears Rowe does not take seriously the ‘chicken and egg’ problem with neoclassical models – surely, production must occur first, yet models such as Arrow-Debreu take prices as a given for firms, before anything is made.”

        In fact, Rowe has a nice post about this: http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/06/linearity-and-the-concrete-steppes.html

      • #6 by Unlearningecon on September 14, 2012 - 5:08 pm

        So because lots of things occur simultaneously, we should just say prices appear out of nowhere? Only SFC approaches use the technique espoused by Marshall.

        There are different approaches to be taken. But, at the beginning of time, production must occur before consumption.

      • #7 by ivansml on September 14, 2012 - 5:23 pm

        They don’t come out of nowhere, they’re determined simultaneously with quantitites. As Marshall argued, the concept of equilibrium doesn’t imply any single direction of causality, so you are criticizing something that’s not claimed by neoclassical theory.

      • #8 by Unlearningecon on September 14, 2012 - 5:24 pm

        Determined by what? The firm is a price taker.

      • #9 by john77 on September 14, 2012 - 5:41 pm

        Not every firm can be a price-taker.
        Innovative market-leaders (i.e. those firms that produce a product that is better both in a simple technical sense and in value-for-money) *have* to be price-setters.

      • #10 by Unlearningecon on September 14, 2012 - 5:42 pm

        Absolutely, John – Arrow-Debreu is an odd model that seems to have been made for purposes other than representing the real world.

      • #11 by ivansml on September 14, 2012 - 5:53 pm

        If you have system of equations
        ax + by = c
        dx + ey = f
        and the solution is x*, y*, does x* cause y* or vice versa? That question is nonsensical – all we can say is that x* and y* are determined simultaneously by the system.

        It is possible that the true physical process starts with some value of x0, which causes y1, which causes x2, which causes y3,… until convergence, so one could say that the true cause is x. It’s also entirely possible to be the other way round, or some different way entirely. Therefore even if you say that x doesn’t cause y, this doesn’t mean that the system of equations is false.

      • #12 by Unlearningecon on September 14, 2012 - 6:33 pm

        But you haven’t even asked the question of whether that system of equations represents the real world.

      • #13 by Mathieu Dufresne on September 14, 2012 - 10:38 pm

        The example gave by ivan is a positive feedback loop, in which case the causality is circular. If you’re working with simultaneous differential equations, effectively “one condition does not control another, but altoghether they mutually determine one another”.

      • #14 by Unlearningecon on September 14, 2012 - 10:51 pm

        Absolutely, Mathieu – all I’m saying is that it is a pure mathematical question with no reference to actual production. For example he has not said where the equations that determine p and q come from.

  4. #15 by Sean Fernyhough (@Sean_Fernyhough) on September 13, 2012 - 8:50 pm

    “…most of the crucial decisions shaping the economic structure occur in the productive sphere, e.g. what shall be produced, how produced, at what price, and most important of all, how much each consumer is given to spend on consumption. The poor fellow can still claim that he alone determines how he spends it, but even this is being seriously eroded in our advertising-ridden society.”

    R.M. Goodwin, page 2 “Elementary Economics from the Higher Standpoint” Cambridge University Press 1970

    “It must never be forgotten, that in capitalist production what matters is not the immediate use-value but the exchange value, and, in particular, the expansion of surplus value. This is the driving motive of capitalist production, and it is a pretty conception that – in order to reason away the contradictions of capitalist production – abstracts from its very basis and depicts it as a production aiming at the direct satisfaction of the consumption of the producers.”

    K Marx, “Chapter XVII – Ricardo’s Theory of Accumulation and a Critique of it” in “Theories of Surplus Value 1861-1863″ Capital – A Critical Analysis of Capitalist Production”

    Don’t people read Richard Goodwin any more? Do people admit to reading Karl Marx?

    These are abstractions from economic complexity. In reality we are still waiting for the euthanasia of the rentier and there are also publicly provided goods and services.

    However we do not need an economics that abstracts from economics itself, and says the economic value of any good or service is a mental state of mind because there is an economy out there of measurable money flows and stocks with cause, effect and inter-relatedness .

  5. #17 by Sean Fernyhough (@Sean_Fernyhough) on September 13, 2012 - 8:54 pm

    I just wanted to flag up Naked Keynesian’s post from yesterday http://nakedkeynesianism.blogspot.co.uk/2012/09/a-good-book-on-cambridge-capital.html

    Which provides a link to a electronic book that covers this area.

  6. #18 by john77 on September 14, 2012 - 4:06 pm

    A lot of advertising is about gaining market share rather than creating a new market: none of the most memorable adverts from the Esso Tiger and Marlboro Man to the Meerkat have been to increase total product sales. However I should agree that it is quite difficult (except for Apple) to evidence demand for a product that has not yet been invented.
    As a mere human being I find Saffra’s concept that the “distribution between wages and profits must be known before prices can be calculated” untenable since ceteris paribus a change in output prices has no effect on wages *unless* one makes a series of unrealistic assumptions;

    • #19 by Unlearningecon on September 14, 2012 - 4:32 pm

      Have those adverts really not increased market share? Or increased market share relative to what would have been without them?

      The Sraffa point is more technical than that: the price of inputs depends on the distribution of income. But I won#’t get into that here.

    • #20 by john77 on September 14, 2012 - 5:35 pm

      Excuse me but you are assuming that my comment answers a claim at an obtuse angle to what you actually said. ” it seems illogical to say that the demand for a particular good comes first, then the supply follows as firms passively try to accommodate it. If it were true, advertising wouldn’t exist,”
      Tony the Tiger did not increase petrol sales – the largest single contributor to increased petrol sales was Henry Ford.
      It is almost certain that iconic adverts increase market share, but your post implied that they created a market out of nothing.
      Did Sraffa believe in the existence of self-employment?

    • #21 by Unlearningecon on September 14, 2012 - 5:37 pm

      Oh I see, sorry – I’m not switched on.

      I think you are correct that advertising is not what creates the market – the existence of a product does that. But production still comes first here.

      • #22 by john77 on September 14, 2012 - 6:03 pm

        I quite agree (as I tried to indicate) – except for a tiny handful such as “Sunny Delight” and the iPhone. I was just pointing out that advertising does not rely on the creation of new products to fund its lifestyle.
        Asimov and Heinlein (in his early years before he went “off”) have created demand for products that were invented after their deaths but most demand only emerges after people are aware of the existence of the product/
        Examples – robotic cleaners, computer-guided trains and solar PV panels

    • #23 by Sean Fernyhough (@Sean_Fernyhough) on September 14, 2012 - 9:42 pm

      Reading, and understanding, Sraffa over a period of weeks, months and years is a mind altering experience.

      Profit and wages (the latter as a cost of production and the former as a mark-up on costs of production) are a component of price.

      Sraffa’s point of departure was his 1926 paper: The Laws of Returns under Competitive Conditions:

      http://pchen.ccer.edu.cn/homepage/Homepage%20Chinese/AED2003/readingpapers/DDSS/SraffaReturn26.pdf

      • #24 by john77 on September 17, 2012 - 2:51 pm

        “Reading, and understanding, Sraffa over a period of weeks, months and years is a mind altering experience”
        Unlike Louise Mensch, I prefer to limit my drugs to caffeine when working and alcohol (in moderate amounts) when dealing with really irritating people,
        Quite frankly, you *appear* to be confusing cause and effect. Profit is an effect of the difference between prices and cost (including wages); it cannot on itas own determine prices unless the producer has an absolute monopoly.

      • #25 by Sean_Fernyhough on September 18, 2012 - 3:28 pm

        In writing this I am not – of course – showing any confusion of cause and effect. How does one arrive at equilibrium prices without knowing profit? Most especially as the costs of production will include the profits of industries that are providing inputs into process of the particualr industry in question.

        In terms of issues of price determination by firms I think Sraffa’s 1926 paper is an interesting read. Clearly individual firms do not have horizontal demand curves.

      • #26 by Unlearningecon on September 18, 2012 - 5:03 pm

        Exactly – the costs of production include both wages and profit, and so will vary with the distribution between the two.

  7. #27 by Matías Vernengo on September 17, 2012 - 2:20 pm

  8. #28 by Magpie on September 18, 2012 - 1:34 am

    “In a modern capitalist economy, it seems illogical to say that the demand for a particular good comes first, then the supply follows as firms passively try to accommodate it. If it were true, advertising wouldn’t exist, or would be incredibly limited.”

    That’s a very good point and one many people seem to neglect.

  1. Sraffa Debates | Economic Thought
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