What on Earth is Utility, Anyway?

In mainstream economic models, consumer’s behaviour is generally assumed to follow a ‘utility function.‘ Consumers derive utility (creatively measured in ‘utils’) from whatever they consume, and they will attempt to maximise this subject to their budget constraint – and, perhaps, at a later level, some extra terms to incorporate behavioural quirks, social pressure or what have you. Unfortunately, even with modifications, the concept of utility is an explanation of behaviour that is questionable at best.

The first conundrum – as posed in the title of this post – is exactly what form utility takes. Is it supposed to be some sort of cumulative attribute that people collect as they go through life, like a stat on a video game? Or is it a temporary sensation experienced after consumption, so that economic agents are effectively utility junkies, chasing around temporary highs? There may be a case for regarding anyone who truly maximised utility as clinically insane and in need of help. In any case, thoughtlessly following predetermined utility functions leaves neoclassical agents with no real room for ‘choice’ – we know what their behaviour will be in advance, and it is unchangeable.

There is also the problem of fungibility: is it fair to suggest that joining a gym gives someone the same kind of satisfaction as eating a donut? Or that eating a donut gives the same feeling as owning a car? These nuances are lost in the aggregated world of ‘utils,’ a unit which has no relation to anything else and hence is hard to verify – at its worst, utility is simply circular: only measurable by the same behaviour it supposedly explains.

Economists have a standard response to contentions that utility is unrealistic. They will assert that, even though utility doesn’t really ‘exist’ – a position few would endorse, surely – it still follows that if preferences follow economist’s axioms, then an effective utility function can be derived. That is: utility is not meant to be taken literary, but economist’s assumptions are sufficient to ensure a relationship between preferences that is functionally the same thing. So it would appear the only way out for opponents of utility is to critique the axioms. I don’t believe this is true, but the axioms are worth critiquing before I explain why.

The two most important axioms required to derive a basic utility function are completeness and transitivity. There are other axioms that are also commonly used – independence, non-satiationconvexity – which are all vulnerable to criticisms, but since they pertain to the the exact form of a utility function, rather than the concept as a whole, I will focus only on completeness and transitivity. Without these, there is no utility function, whichever way you paint it.

The first axiom – completeness – is the idea that all relevant decisions can be definitively compared to one another: that is, there is no room for ‘I don’t know.’ There are clear problems with this. Often, it is hard to choose between two options, particularly if one is a bundle of many goods (e.g. two shopping baskets). In fact, as a decision rule this is generally computationally impossible. So people may act based on chance or impulse; they may seek advice or ask someone else to make the decision for them. What’s more, often people find it difficult to evaluate choices even after they’ve made them. Sometimes there is no ‘correct’ choice!

The other axiom, transitivity, implies that people will be consistent in their ordering of preferences. If I prefer A to B, and B to C, I will prefer A to C. It is an important axiom because, even if preferences are complete, a violation of transitivity means that utility functions can basically have any shape and therefore be pretty useless for clear calculations. While I expect numerous behavioural quirks suggest transitivity may be violated under certain circumstances, overall it is a fair axiom – for the individual. However, it has been known for some time that, once we have more than two agents, it becomes impossible to establish a clear, consistent ordering of preferences for the group. This isn’t moving the goalposts: it is highly relevant when we are using representative agents for the entire economy. (This problem also applies to the aforementioned independence axiom).

My most important point, though, is that even if preferences do follow all the axioms, utility is still highly flawed. This is because, like so many neoclassical models, all utility functions give us is a static snapshot of the economy (or individual) at a particular point in time, and there is no room for change. The simple fact that preferences are highly volatile and will be different in the morning and the evening, or in summer and winter, is enough to render utility useless for practical questions about the economy, which must surely incorporate time. Similarly, preference reversal has shown that the way options are presented has a large impact on the choice made by somebody, suggesting again that underlying ‘preferences’ are highly subject to change, and not really useful for the practical purpose of predicting behaviour. One can only wonder how utility might deal with a theory such as multiple selves, which would surely create the aforementioned aggregation problems for preferences, but for one person!

Now, I can almost hear the cries of “ah, but what is your alternative?” Actually, that doesn’t matter for the immediate critique. If I have a map of London Underground and I’m in New York, I’m not going to use it (even less so if I have a map of a fantasy land that exists only in the minds of economists). To push the analogy a little further, it is worth asking what I would do in this situation. I can think of two possibilities: either ask for help, or follow some simple rules of thumb based on what knowledge I have. This is the strategy economists should adopt.

In the case of ‘asking for help,’ what I mean is that economists should turn to other social sciences; namely, psychology, which has a far more empirically driven methodology than economics and has numerous explanations of behaviour. Economists truly interested in understanding human behaviour – rather than preserving their favoured assumptions – should collaborate with psychologists to create sound behavioural foundations.

Until then, economists should be content with simple empirically observed rules of thumb and intuitive aggregate relationships (they already do this with the marginal propensity to consume). Objections of ‘but Lucas Critique‘ are special pleading, since preferences are also liable to change with political decisions. In fact, I’d shout ‘Lucas Critique’ right back at economists, and suggest that they spend less time on the impossible task of making their models ‘immune’ to the Lucas Critique, while spending more evaluating the ever-changing relationship between policy and observation. It is better for economists to be vaguely right than precisely wrong.

Out of all the concepts in neoclassical economics, none is more imaginary, absurd and empirically falsified than utility. Economists supposedly follow a methodology of strict positivism, and based on the experimental evidence against utility, there is surely no reason to keep it. Yet for some reason, it doesn’t seem to attract the same level of criticism as other areas of neoclassical economics. Personally, I am puzzled as to why.

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  1. #1 by Robert Nielsen on March 6, 2013 - 5:00 pm

    After three years of economics study in university, I still have no idea what the point or use of utility is. It is as hard to understand as it is to find a use for it. It has caused nothing but headaches among my class. Good job on excellent post.

    • #2 by Luis Enrique on March 12, 2013 - 11:46 am

      so much the worse for your university lecturers (or your studying ability).

      Suppose you know how much various goods cost to produce, how would you go about explaining prices without saying something about how much people like (demand) these goods? You know Ferraris cost more to produce than Fiat Puntos, but why is Ferrari able to find buyers for its cars at a price that covers the costs? Suppose I expend the same amount of “labour value” as goes into building a Ferrari on constructing a car out of glued together toenail clippings and tummy button fluff, unless a collector of modern art takes a shine to it, can you say anything about what price I will get for it?

      Even if you tried to discard utility, maths and all the other stuff you don’t like, you would end up implicitly appealing to some thing very similar to utility (which is just a convenient means of representing preferences) if you want to say anything about what people buy at what prices.

      • #3 by Unlearningecon on March 12, 2013 - 12:23 pm

        so much the worse for your university lecturers (or your studying ability).

        So this time it took 3 comments before you stooped to insults, perhaps a personal best?

        I guess all my firsts and 90s were just flukes.

        I’m not an adherent of the LTV, as I like to point out, but it is easily equipped to deal with the problem you point out (which is just a variant of the diamonds-water paradox). The LTV applies to averages across time, not just a particular good or industry. So the culmination of the research and development put into Ferraris and their constituent parts contributes to the higher price.

        In any case, nobody suggested abandoning preferences altogether (not even Marx). They just aren’t all there is, and if you try to reason from them, you end up with a circularity problem, since prices must exist before preference-related calculations can take place.

        Even if you tried to discard utility, maths and all the other stuff you don’t like,

        I like maths. That’s why I’d prefer economists to use more modern techniques, rather than the kind of outdated stuff a first year or even first term maths student would find elementary (and I say that from experience). Honestly why you people are so self congratulatory about your maths skills baffles me.

        you would end up implicitly appealing to some thing very similar to utility (which is just a convenient means of representing preferences) if you want to say anything about what people buy at what prices.

        Nah, I’d probably just show some humility and ask a psychologist or even biologist, as they have many explanations of what’s going on that don’t rely on utility.

      • #4 by Luis Enrique on March 12, 2013 - 2:25 pm

        UE

        I was addressing Robert Nielsen, who says he spent three years studying economics at university and came away without understanding the first thing about why economists use utility functions. I say this either reflects badly on his teachers or on his ability as a student. That’s “stooping to insults” is it?

        if you try to reason from them …

        You did read Binmore’s introductory chapter, right? Maybe re-read the bit about the causal fallacy. There’s nothing to stop you from saying “suppose people have preferences that imply a utility function that looks like this, which implies demand functions like so …” but if you are trying to predict behaviour you reason from observed choices backwards to preferences, not the other way around.

        So the culmination of the research and development put into Ferraris and their constituent parts contributes to the higher price.

        yes it’s clear the costs of producing a Ferrari are high, but why are people willing to pay the price for it, unless in some sense the derive more pleasure (or whatever term you prefer – status maybe) from owning a Ferrari than from owning a Fiat Punto?

        Well I admire intellectual humility. I’ve not seem much evidence of it in your approach to the work of mainstream economists, whom you seem mainly concerned with rubbishing, as is your chosen vocation.

        I claimed that one will struggle to explain prices without referring to preferences, which utility functions are merely a convenient representation of. Can you point me to something from a psychologist or a biologist that could explain why people are willing to pay different prices for different goods without recourse to something not dissimilar to a utility function (i.e. some description of preferences, something that describes how decision makers evaluate the consequences of their decisions?) I mean great, let’s appeal to evolutionary or socially determined preferences (economists prefer to set aside the question of where preferences come from, but that’s only because they are interested in different questions) but in all humility I still expect any answers coming from psychology or a biology to end up invoking something that does the job economists use utility functions for.

      • #5 by Unlearningecon on March 12, 2013 - 4:32 pm

        Ah, couldn’t see who it was in response to in the format I was reading the comment. It looked like you were just insulting various facets of my education out of nowhere. I suppose we are destined to have occasional exchanges punctuated by one of us losing our temper.

        Also, I don’t adhere to the LTV so I won’t defend it; whatever defence I could offer would not be well informed enough. I certainly think that preferences have something to do with determining prices.

        Well I admire intellectual humility. I’ve not seem much evidence of it in your approach to the work of mainstream economists, whom you seem mainly concerned with rubbishing, as is your chosen vocation.

        Shoulders of giants etc. I rely mostly on previous critiques and rarely claim originality. All I’m trying to do is avoid the traps that disparate critiques often fall into.

        Can you point me to something from a psychologist or a biologist that could explain why people are willing to pay different prices for different goods without recourse to something not dissimilar to a utility function (i.e. some description of preferences, something that describes how decision makers evaluate the consequences of their decisions?)

        See, for example, this paper, or the book predictably irratiola, which Robert Nielsen above has usefully blogged. It seems to me that, while utility can be inferred from any particular situation, changing the environment so changes the ranking of preferences (e.g. anchoring biases) that no steadfast utility function can be maintained.

      • #6 by Luis Enrique on March 12, 2013 - 2:25 pm

        oh ball, html failure

      • #7 by Luis Enrique on March 12, 2013 - 4:56 pm

        afaik the assumption of static preferences is not made because economists think preferences are static, it is made because it’s hard enough dealing with static preferences (although Google Scholar will locate economics papers on preference formation and dynamic preferences if you want them)

        I haven’t finished reading the Simon paper but was amused to read this bit: “The environment we shall discuss initially is perhaps a more appropriate one for a rat than for a human”

        remember nobody thinks rational decision making models are applicable in all contexts, Binmore for example is quite explicit on that point. Dan Ariely’s work is very interesting, but I don’t really say it as a replacement for explaining price determination. I don’t know Simon’s work terribly well, but I am under the impression he’s not a million miles away from bounded rationality which looks to me like a very attractive development, but doesn’t render more basic econ 101 decision theory worthless. It’s more like an extension of basic theory. Although having written that I dimly recall reading Simon is in fact quite different from bounded rationality.

      • #8 by Luis Enrique on March 12, 2013 - 5:01 pm

        Here’s another excerpt from that SImon paper:

        “1. It has only a single goal: food. It does not need to weigh the respective advantages of different goals. It requires no “utility function” or set of “indifference curves” to permit it to
        choose between alternatives”

        right, well straight away you can see what Simon is doing won’t be much help accounting for choices between competing goods/ outcomes, so I don’t think that paper shows how psychologists or biologists could explain price determination without recourse to some utility functionesque object.

      • #9 by Luis Enrique on March 12, 2013 - 5:07 pm

        having read further, I see SImon extends his framework to multiple goods. So his animal is in an environment with piles of these multiple goods spread randomly around, and once the animal has had enough of one good, it sets off searching for another good. Hence it can potter about and so long as it limits its time spent consuming any particular good, it can expect to find all it needs.

        well fine, there might be some aspects of economic life that are well described, in a highly stylized and simplified fashion, but that sort of model, but it doesn’t look to me much like the problem I face when I go to the supermarket nor yet a replacement for the work utility functions do throughout economics.

        by the way, the link to the paper you provided didn’t have a pdf link, I think you can get it here (might be £ gated)

        http://psycnet.apa.org/journals/rev/63/2/129.pdf

  2. #10 by DW on March 6, 2013 - 6:03 pm

    You seem content to stop asking questions a step before they really get interesting.

    Ex 1: “Economists should just assume firms use mark-up pricing.” Never mind HOW a firms decide what the mark-up should be.

    Ex 2: “Economists should just assume people follow basic rules of thumb when making decisions.” Never mind HOW people choose which rules-of-thumb to adopt.

    When you get past treating firms and people like black boxes and start trying to answer THOSE questions, I think you will find yourself right back where you started. Firms choose mark-up in order to maximize profits subject to some constraints (like information or cognitive ability). People adopt the rules-of-thumb that most closely maximize some objective function (like i dunno utility) subject to some constraints (like information or cognitive ability).

    Of course, acknowledging information and cognitive ability constraints is one thing. Translating models that incorporate those constraints into testable hypotheses is another. There is not too much data on “cognitive resources available for evaluating prices”.

    • #11 by Unlearningecon on March 6, 2013 - 6:26 pm

      Your assertions are not quite the ‘gotchas’ you seem to think, simply because they are just that: assertions.

      Firms choose mark-up in order to maximize profits subject to some constraints (like information or cognitive ability).

      Actually empirical evidence suggests firms have many different strategies. Even those seeking profit using cost-plus pricing are not ‘profit maximising subject to constraints;’ they are ‘satisficing‘ a certain level of profit.

      People adopt the rules-of-thumb that most closely maximize some objective function (like i dunno utility) subject to some constraints (like information or cognitive ability).

      Why invoke utility? You have made no argument for it; you simply fall back on it. Again, people don’t ‘optimise’ anything.; research shows that people are more likely to satisfice. In other situations people don’t necessarily know what they are doing and have no clear goal. In others the means of the action, rather than some ‘goal,’ are what’s important. Utility is just a way to make mathematics tractable where it actually isn’t appropriate.

      Of course, acknowledging information and cognitive ability constraints is one thing. Translating models that incorporate those constraints into testable hypotheses is another. There is not too much data on “cognitive resources available for evaluating prices”.

      Irrelevant. Doesn’t mean we should fall back on an empirically falsified model. Though actually there is plenty of research by psychologists and economists, as shown in the link above.

      • #12 by DW on March 6, 2013 - 6:37 pm

        You also have a pretty low bar for for making sweeping statements.

        “Evidence shows…”
        *Link to decades-old survey study of questionable quality*

      • #13 by Unlearningecon on March 6, 2013 - 6:56 pm

        How is it of ‘questionable’ quality? Shipley is widely cited and used in textbooks such as mine (Industrial Organisation: Competition, Strategy and Policy).

        In any case, it’s better than no evidence. I’d be surprised if you could find a study that concludes the majority of firms are ‘maximising’ profits in the sense meant in neoclassical economics (e.g. not merely satisficing).

  3. #14 by Dan on March 6, 2013 - 9:10 pm

    “To push the analogy a little further, it is worth asking what I would do in this situation. I can think of two possibilities: either ask for help, or follow some simple rules of thumb based on what knowledge I have. This is the strategy economists should adopt……In the case of ‘asking for help,’ what I mean is that economists should turn to other social sciences; namely, psychology, which has a far more empirically driven methodology than economics and has numerous explanations of behaviour.”

    The rules of thumb you are talking about are called “heuristics”, things that psychologists who study decision making have been mapping out for years. They’ve actually mapped out a lot things about human behavior that far too many economists remain ignorant of. I am not an economist by training, my degrees are in Psychology and Law, but when I did start getting into economics, it did (and still does) astound me how so many micro focused economists rely on assumptions about human behavior that are so simplistic and outdated. There have been great advances in psychology and neuroscience over the years (every day really) yet so much of economics is stuck in an understanding of human behavior that seems like its from the 1940s. And “utility” is one of the worst of them all, though not nearly as bad as praxeology, which is just pure shite.

    • #15 by Unlearningecon on March 7, 2013 - 1:32 pm

      I should have been clearer: in that paragraph, I meant the economist’s own derived ‘rules of thumb’ based on experience and data, rather than those used by the agents themselves.

      But yes, you are right. It amazes me how many economists seem to think there is no alternative to utility.

  4. #16 by ittecon on March 6, 2013 - 10:22 pm

    Hasn’t Kahneman’s and Tversky’s prospect theory pretty much put utility theory to bed? I didn’t realise anybody took utility theory seriously for the past 30 years or so. Did I miss something?

  5. #21 by Silvano on March 6, 2013 - 11:04 pm

    Utility functions are just a way to rank preferences and treat them in plain math. They are assumed by the modeler, no one thinks they *really* exist (but yes, many teach them as if they were real…).

    Broadly speaking there are three kind of models:
    – Rational choice
    – Behavioral models
    – “Rule of the thumb” and Agent Based Models

    They all have something to say in order to explain social phenomena and they’re all subject yo episthemic limits.Rational choice models shouldn’t be taken like a dogma; surely they are questionable but you don’t have to drop the baby with the water.

    • #22 by Unlearningecon on March 7, 2013 - 1:30 pm

      I’m not sure for which domain utility is valid though. What do you have in mind?

      • #23 by Silvano on March 7, 2013 - 2:19 pm

        Partial equilibrium models, Comparative Static, Repeated Games, etc.

        For sure RCT posits an inaccurate, unrealistic psychology, and all else equal, this counts against the theory but to argue that RCT rarely led to accurate predictions is to dismiss essentially all of microeconomics and hundreds of studies in sociology and political science as well as other fields.

        We even do not know what rationality exactly means, nonetheless economists who use the rationality postulate come up with better work and better ideas than those who completely disregard rationality assumptions. It’s a useful heuristic for economists even if they know it’s not descriptively true.

      • #24 by Unlearningecon on March 10, 2013 - 3:31 pm

        For sure RCT posits an inaccurate, unrealistic psychology, and all else equal, this counts against the theory but to argue that RCT rarely led to accurate predictions is to dismiss essentially all of microeconomics and hundreds of studies in sociology and political science as well as other fields.

        This is not necessarily true. Just because utility-based theories lead to useful predictions, it does not mean we need to invoke utility to preserve the existence and validity of these theories.

        We even do not know what rationality exactly means, nonetheless economists who use the rationality postulate come up with better work and better ideas than those who completely disregard rationality assumptions. It’s a useful heuristic for economists even if they know it’s not descriptively true.

        Well, it seems to me that alternative theories such as Marx, Keen and Sraffa do not rely on rationality. Even simple rules of thumb like the marginal propensity to consume are not rationality based but useful.

  6. #25 by Blue Aurora on March 7, 2013 - 5:57 am

    At last, you get closer to the subject that I suggest you discuss in further depth, Unlearningecon. In an earlier post on this blog, you mentioned that William Stanley Jevons himself doubted the usefulness and applicability of “utility functions” to actual decision-making itself. However, you still haven’t named the three culprits that were responsible for the formulation of Subjective Expected Utility: Bruno de Finetti, Frank P. Ramsey, and Leonard J. Savage. Go back to the primary sources on these matters.

    Then read Allais and Ellsberg’s articles on their paradoxes. S.E.U. decision theory is in fact a very special case.

    • #26 by Dave Marsay on March 11, 2013 - 7:03 pm

      In defence of Ramsey and Savage, their theories only apply to what Savage calls ‘small worlds’, and it doesn’t take much to violate their axioms. Von Neumann is another alleged advocate of utility theory, but he gives some counter-examples. E.g. search on djmarsay.wordpress.com.

      If anyone has a genuine mathematical source for the universal number-based concept of utility, I would be glad to see it. As far as I can see in a world that is not necessary stable any utility would have to depend on an uncertain context, and so would itself have to be uncertain, and hence more than just a number.

      • #27 by Unlearningecon on March 11, 2013 - 7:29 pm

        It does not surprise me that the fathers of SEU theory thought there was a limited domain for their ideas; in fact, I might well agree (repeated games being the obvious example). I wonder whether we should blame the authors, as Blue Aurora seems to think, or blame those who misinterpreted them.

      • #28 by Blue Aurora on March 13, 2013 - 12:17 pm

        Perhaps I ought to clarify myself…

        Yes, Dr. David J. Marsay is correct. I’m not so sure about Frank P. Ramsey’s situation, but I’m pretty sure that Leonard J. Savage did concede that Subjective Expected Utility (S.E.U.) decision theory had rather high criteria to be used.

        As a matter of fact, Daniel Ellsberg’s seminal 1961 article in the Quarterly Journal of Economics, “Risk, Ambiguity and the Savage Axioms”, he names people upon whom he performed his experiment. One of them was Leonard J. Savage himself. According to Ellsberg’s article, Savage acknowledged that he ended up violating his own “Sure-Thing Principle”, and he wasn’t happy about that.

        Regardless of the fact that Savage and other advocates of S.E.U. did concede that S.E.U. had limitations, this didn’t stop the economics profession from adopting it and making it essentially the standard decision theory in academic economics. After all, acknowledging the limitations of a particular theory doesn’t mean that one isn’t the same thing as admitting that you’re wrong or incorrect. And given the experimental evidence that has been done over and over again affirming Ellsberg’s critique of the Savage Axioms, shouldn’t it be obvious that S.E.U. theory is far from an appropriate grounding? It seems given the experimental evidence, that S.E.U. needs to be more readily acknowledged to be a special case, used only as a small pedagogical device, and be replaced by a decision theory that is more comprehensive and general in descriptive power.

        While I can’t pull up references in this instance, I have read writings that do indicate that advocates of S.E.U. that followed Savage did concede and in fact, did so quickly to their critics.

        So I seriously doubt that people misinterpreted Savage (and other advocates of S.E.U. theory), either deliberately or unintentionally. Nor do I think that the founders of S.E.U. theory were misunderstood en-masse.

        I am not saying that we should blame the creators or people who followed them and misunderstood/misinterpreted them.

        What I was saying to Unlearningecon, was that he should review the primary sources themselves to properly understand how S.E.U. works, then read the famous critiques by Maurice Allais and Daniel Ellsberg.

        What I am saying is that one should be upset over the fact that S.E.U. is being used as the underlying foundations for microeconomic theory and macroeconomic theory. Logically followed through properly, this results in a descriptive theory that is much more restrictive in nature than need be.

        This also results in policy recommendations by economists that don’t fully take into account what in practice, is the non-linearity and non-additivity of decision-making processes.

        The acceptance of S.E.U. theory as the underlying foundation can be seen even in Keynesian economists. Just read James Tobin’s 1958 article in the Review of Economic Studies, “Liquidity Preference as Behavior Towards Risk”.

        http://cowles.econ.yale.edu/P/cm/m19/m19-01.pdf

        In it, you’ll find that Tobin cites a 1948 article jointly written by Leonard J. Savage and Milton Friedman. Tobin also cites Leonard J. Savage’s The Foundations of Statistics (1954).

        Until the axioms of S.E.U. theory are replaced with something that is more comprehensive in descriptive power and hold much better in many different conditions, economic theory and economic policy recommendations – in my view at least – won’t be as effective or as accurate as they can be.

  7. #29 by Boatwright on March 7, 2013 - 3:36 pm

    The lack of mathematical rigor and testability against actual behavior in economic models of how individuals and firms make economic choices is truly staggering.

    None of the mathematically simple, always yielding a linear downsloping or upsloping, functions stand up to the most basic real-world conditions of a shopping cart with dozens of items, or a competitive environment with many firms offering hundreds of similar products. Any number to the nth power quickly becomes a computational nightmare. Nevertheless, these mathematically ridiculous building blocks remain embedded in the foundations of economic theory.

    Economics must look to the mathematics of stochastic systems, and admit that there is no such thing as economic fine-tuning. Or more fundamentally: Such efforts are epistomologically impossible. Real world decisions are made heuristically. There is no such thing as the always rational economic actor.

    Better to look to balanced laws setting the rules for sound banking and financial market practices, and the simple regulation of economic results, such as consumer safety, environmental protection, and economic crime. Economists need to give up their priesthood of explanations of all things and let the chaos and oscillations of real-world markets proceed by themselves.

    • #30 by Unlearningecon on March 8, 2013 - 7:48 pm

      I think that economics as currently framed is a barrier to effective management, as the reductionist approach fails to see things systemically. Consider VaR risk regulation where banks had to sell assets during volatile times. This seems sensible from the perspective of one bank, but from the perspective of the system it simply increased volatility and made them sell more assets – a positive feedback loop.

      I also find the idea of ‘the market’ an arbitrary concept, as the line between institutions required for markets and their ‘regulations’ is blurred to non existence.

      I’m convinced common sense, some basic chaos concepts carried over from physics/biology, coupled with political debates about redistribution and power etc. would do a far better job.

      • #31 by Dave Marsay on March 11, 2013 - 7:05 pm

        Any merit in including some more appropriate mathematics in that prescription?😉

      • #32 by Unlearningecon on March 11, 2013 - 7:30 pm

        Of course – I think it was implied in the chaos theory suggestion.

      • #33 by Dave Marsay on March 11, 2013 - 9:13 pm

        Turing’s work on morphogenesis might usefully be included under a broad interpretation of ‘chaos’. (One of my concerns is that complexity theory was re-invented from scratch, and it took too long to rediscover Turing, for example, and ‘they’ still don’t seem to have got around to Whitehead.)

  8. #34 by Eric L on March 9, 2013 - 8:55 pm

    I think the idea of utility was to come up with a decision theory so vague and general such that one could plausibly assume that if better theories of behavior existed they would simply describe a subset of the behaviors that are described by utility theory. And it is quite general; for example, Maslow’s hierarchy of needs can be expressed as a utility function. So the dream of utility is that if economists could start there and derive rules of economics that were invariant across a wide class of utility functions, then they could make progress without knowing the messy details of human psychology.

    At times it is too general to answer the interesting questions you want to answer, but it can also be too limited. It doesn’t distinguish between first-order and second-order wants — what’s the utility of a cigarette to a smoker who wants to quit? And we’ve all experienced that we’ll make different decisions if we go shopping when we are hungry than we will if we shop well in advance of dinner. We’re not typically trading off a future dinner with present consumption, so how we discount our future dinner can’t really explain the difference.

    That said, I get the impression that utility really draws economics critics because it is an easy target, but it’s not a particularly consequential one. All the problems in macro don’t have much to do with it. Behavioral economics is catching on where it is relevant and incorporating more psychology into microeconomics, though more of it should be brought into Econ 101.

    • #35 by Unlearningecon on March 9, 2013 - 11:33 pm

      Thanks for your comment. Joe Stiglitz commented recently that time inconsistency kills utility maximisation.

      And it is quite general; for example, Maslow’s hierarchy of needs can be expressed as a utility function.

      Hmm? Seems to me a function U (basic needs, safety, love, self esteem, self actualisation) would not work as the significance of one would be dependent on the others being fulfilled. Unless I just lack imagination.

      That said, I get the impression that utility really draws economics critics because it is an easy target, but it’s not a particularly consequential one. All the problems in macro don’t have much to do with it. Behavioral economics is catching on where it is relevant and incorporating more psychology into microeconomics, though more of it should be brought into Econ 101.

      Perhaps. though bear in mind many DSGE papers do incorporate utility maximising agents. And economists don’t like models that don’t have this (eg Steve Keen).

      • #36 by M Gubb on March 11, 2013 - 1:49 am

        It would be easy to have utility as a vector instead of a single number, and a comparison based on a ranked version of the components (i.e. compare the first, if they are unequal one is better, if equal then compare the second etc.). You could even turn it into a single number if you had discrete values for each or you rounded the value, then put them together with the most significant part being the top of the hierarchy.

      • #37 by Unlearningecon on March 11, 2013 - 7:08 pm

        Ah, makes sense, thanks. I found this paper on the subject if you’re interested.

  9. #38 by Luis Enrique on March 11, 2013 - 4:43 pm

    Chapter 1 of Ken Binmore’s Rational Decisions is available for free online

    http://press.princeton.edu/chapters/s8902.pdf

    excerpt:

    “The story begins with Jeremy Bentham’s adoption of the term utility as a measure of the pleasure or pain a person feels as a result of a decision being made. Perhaps he thought that some kind of metering device might eventually be wired into Pandora’s brain that would show how many units of utility (utils) she was experiencing. This is a less bold hypothesis than it may once have seemed, since we now know that rats will pull a lever that activates an electrode embedded in a pleasure center in their brains in preference to anything else whatever—including sex and food.”

    It might clear up a few questions. It might even persuade some that economists aren’t as daft as y’all think.

    • #39 by Dave Marsay on March 11, 2013 - 7:11 pm

      But does the brain really work like this when assessing uncertainty? For example, does the effective probability of X plus the effective probability of ¬X always add to 1, and are their values independent of the context?

    • #40 by Unlearningecon on March 11, 2013 - 7:21 pm

      That paper takes a common approach, which is defending the axioms. But I highlight why I don’t think that is sufficient for defending utility in the post.

      Also, rats aren’t people! But even though people surely do that, it doesn’t mean that such an approach is quantifiable, or can be applied to all types of human action.

  10. #41 by Luis Enrique on March 11, 2013 - 7:39 pm

    Oh for Goodness sake, Binmore isn’t appealing to a neurological embodiment of utility, he’s teasing. Rats indeed. He explocitly disavows such psychological interpretations. Did you really read it? Did you read section 1.9? Did you read the bits about how people get confused because they mistakenly think utility theory is about Benthamite pleasure. Read it again, he’s explaining why the bulk of this post is based on a misunderstanding of what a utility funtion is.

    • #42 by Unlearningecon on March 11, 2013 - 7:46 pm

      Perhaps so, but at the price of rendering the theory virtually unfalsifiable – something I allude to in the post with my circularity comment. He directly concedes that it leaves the theory with “little substantive content,” but seemingly considers that an advantage (?)

      • #43 by Dave Marsay on March 11, 2013 - 9:20 pm

        Ellsberg seems to find the theory falsifiable.

      • #44 by Luis Enrique on March 12, 2013 - 5:12 pm

        shouldn’t you also consider that an advantage? The theory starts from observing what people do, and imposes some very minimal conditions (weak preference relations exist and are coherent (transitive) and goes from there. An even those minimal restrictions are too objectionable for your taste. If you want more substantive content, you’d need to add more assumptions that you would surely only find more objectionable.

        by the by, I don’t see it would be too hard to extend basic decision theory to cases where, for example, preferences don’t exist or aren’t transitive, but why would these by interesting cases to model? For example, if preferences don’t exist, one could either model experimentation, copying the behaviour of others (which you would then have to explain instead), excluding such items for the choice set, or even just picking things at random. But we do we wish to build a theory of that? Perhaps we’d need it for some jobs, but it doesn’t strike me as such a limitation of the sort of orthodox theory Binmore sets out in his introductory chapter that it doesn’t consider such possibilities.

      • #45 by Unlearningecon on March 13, 2013 - 6:42 pm

        I think we are talking past each other. I keep emphasising that reason I don’t ‘care’ whether preferences take a certain form is because they are so liable to change with environment, over time and by chance. Positing a utility maximising individual in vacuum is far less useful than, say, positing an environment in which people’s preferences are determined by the outside world. Obviously reality is a mixture of the two but behavioural evidence places me on the side of the latter.

  11. #46 by Steve Roth on March 29, 2013 - 3:58 pm

    Two quick items:

    1. Stanley Wong’s “Foundations of Paul Samuelson’s Revealed Preference Theory.” Routledge 1978, revised edition 2006.

    2. I may be wrong, but preference theory seems to assume a given set of choices, and fails to understand that different choice sets have utility in themselves.

    This goes beyond “preferences are also liable to change with political decisions.” Choice sets are determined by political decisions. Some choice sets are better than others.

    • #47 by Unlearningecon on March 30, 2013 - 12:52 pm

      This goes beyond “preferences are also liable to change with political decisions.” Choice sets are determined by political decisions. Some choice sets are better than others.

      True, This is why the consumer’s role is more passive: the choices available are determined by someone else, whether politicians, firms, political movements.

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