In these difficult times we live in, what economics needs is perhaps, depth and not breadth. Unemployment, poverty, inflation, food insecurity, financial fragility, debt crisis, etc can be better understood and tackled by diverting increased resources (time and financial) in understanding the production, distribution, exchange and consumption of wealth. This blog post very briefly examines Thomas Malthus’s (1766-1834) view of political economy – its method, scope, uses and limitations.  For this purpose, I have used John Pullen’s definitive variorum edition of Malthus’s Principles of Political Economy published as 2 volumes by Cambridge University Press in 1990.

According to the Cambridge Advanced Learners Dictionary, ‘scope’ is defined as the ‘range of subjects covered’. In the context of political economy, scope refers to the range of subjects it covers. That is, the scope of political economy informs us about the sphere of analysis, the boundaries or limits, the kind of situations it describes and its applicability in the real world or, its relevance. Keeping in mind that mathematics played only a small role in political economy during Malthus’s time, let us see what his view of political economy is: ‘the science of political economy bears a nearer resemblance to the science of morals and politics that to that of mathematics’ (p. 2). Undoubtedly, morals played and still play an important role for interventions in the economy based on what we consider to be a ‘good society or economy’. And politics, distributional conflicts over income, land, natural resources and employment are integral part of any economy. Thus, it is important that political economy (and economics) takes into account these distributional conflicts when theorising or modelling an economy. However, for purposes of theory, these conflicts can be taken as given from outside economics (exogenous) or can be determined within economics, in the manner of behavioural economics.

It would not have mattered if political economy was/is not a very important branch of knowledge. Reminiscent of Keynes’s words, Malthus writes: ‘The science of political economy is essentially practical and applicable to the common business of human life. There are few branches of human knowledge where false views may do more harm, or just views more good’ (p. 12). But, Malthus wrote it more than a century earlier. (See also Sismondi’s words of a similar nature). Since Malthus viewed political economy to have significant practical applications, the complete title of his book reads ‘Principles of Political Economy Considered with a View to their Practical Application’. The editor, Pullen, gives us a bit more information on this matter. ‘This was apparently a lifelong concern. As a student at Cambridge in 1786 Malthus wrote to his father: ‘I am by no means, however, inclined to get forward without wishing to see the use and application of what I read. On the contrary I am rather remarked in college for talking of what actually exists in nature, or may be put to real practical use’’ (p. 291, Vol II; all other page numbers excepting this refer to Vol I).

Malthus understands that ‘To trace distinctly the operations of that circle of causes and effects in political economy which are acting and re-acting on each other, so as to foresee their results, and lay down general rules accordingly, is, in many cases, a task of very great difficulty’ (p. 12). Economic processes are caused by a multiplicity of causes and often not by a single one. Owing to this and because of his view of economics as a practical science, he maintained that ‘[t]o know what can be done, and how to do it, is, beyond a doubt, the most valuable species of information. The next to it is, to know what cannot be done, and why we cannot do it’ (p. 17). In other words, we must be very aware of the ‘scope’ of our knowledge.

Furthermore, if our objective is to understand the problems of unemployment and poverty, we must perhaps, as mentioned in the introduction, study in-depth the process of generation and distribution of wealth. I conclude with a statement by Malthus: ‘If we wish to attain anything like precision in our inquiries, when we treat of wealth, we must narrow the field of inquiry, and draw some line, which will leave us only those objects, the increase or decrease of which is capable of being estimated with more accuracy’ (pp. 27-8).

This post clarifies the concept of a utility function, which occupies a very significant position in neoclassical microeconomics. Advances in neuroeconomics and related fields of behavioural economics is constantly challenging the conventional assumptions of microeconomics. This post takes up one such insight by Stephen B Hanauer which was published in Nature in March 2008.

A utility function can be understood in the following way:

U=f(x,y,z) where U is the utility derived from the consumption of x, y and/or z. Alternatively, a utility function transforms combinations of various goods into a single value. Note that x,y and z refer to ‘quantities’ of goods/services consumed.

Suppose, consumer A has the following utility function: U=x+y+z; arbitrary values of x,y and z would result in the following values of U.

That is, microeconomics teaches us that the utility of the consumer is determined by the quantity of goods consumed. An common assumption is that ‘more is better’, which implies that the consumption of more goods gives the consumer more utility. The point to be noted is that microeconomic theory teaches us that utility is strictly a function of quantities. The question posed in this post is whether utility is ‘only’ a function of quantities. What happens if utility is also a function of prices? At this juncture, we need to recollect the objective of utility functions. From the utility function, we derive indifference curves and marginal utilities. Utility or use value of the good or service forms the basis of the demand function, which along with the supply function determines the value/price of a commodity or service. Thus, the use value was employed so as to arrive at the exchange value/relative price of the commodity.

What happens if utility (or experienced pleasantness) is influenced by “changing properties of commodities, such as prices”? That is, can neoclassical microeconomics accomodate the following utility function:

U=f(x,y,Px,Py)

And research in behavioural economics and related areas suggest that prices exert a significant influence on utility and hence on choice and demand. However, if we accept such a utility function, it can no longer be used to explain exchange values/relative prices. Another implication is that prices are no longer determined by the interaction of demand and supply. And the statement that ‘consumer is the king’ no longer holds. Also, producers can adjust prices in such a way as to affect consumers’ utilities. We know that high prices are often associated with better quality and hence higher utility.

The above table can be explained by the following utility function: U=x.Px + y.Py

In this case, a higher price gives more utility to the individual. The maximum utility is when x=y=10 and Px=Py=10.

The other extreme case is when high prices are detested by the individual. For instance, consumers with low incomes will get more utility from consuming goods which are priced less. Their utility function could be represented as follows: U=x.-Px + y.-Py

In which case, the consumers utilities based on the previous values of x,y,Px and Py will be 0, -200, -150 and -80. And the consumer’s utility is maximum when he/she consumes x=y=10 when Px=Py=4.

Empirical evidence suggests that utility is equally influenced by prices of commodities as well. Does this threaten the core of neoclassical microeconomics? This is problematic because neoclassical economics assumes the following to be given: 1) tastes and preferences of individuals, 2) endowments of goods and 3) constant technology. It if from these ‘givens’ that prices and quantities (demanded and supplied) are arrived at through the mechanism of demand and supply/competition/market forces. How can we include the recent findings pertaining to consumer utility and satisfaction in a consistent manner?

Update

The link to the reference was embedded in the authors name. However, because of the comment by Dr. Thomas Alexander, the reference is prrovided below. Also,I acknowledge him for bringing this article to my notice.

Hanauer, S (2008), ‘Experienced Pleasantness,’ Editorial, Nature Reviews Gastroenterology and Hepatology 5, 119 (1 March 2008).

The Economic Survey 2009-10 is different from its predecessors. Of them, it is chapter two of the publication which deserves special attention. The chapter is titled ‘Micro-Foundations of Inclusive Growth.’ This is no new phrase for economists who have witnessed the recent ‘we want microfoundations’ movement in economics. Traditionally, economic survey analysed trends in income, food production, prices, net exports, and so on without telling the readers about their ‘foundations’. For the first time, microfoundations of macroeconomics (a progeny of the failed neoclassical microeconomics enterprise) makes a loud entry into the analysis of the Indian economy.

One of the first signs of this shift is to be seen on the book cover itself. This has been reproduced below, as it is a matter of great concern.

In 2007-08, the cover page indicated various aspects on the Indian Economy. Coupons equilibrium, something which very few people understand gains entry on the cover page. Why? Is it to show that economics is scientific and can only be understood by a few? Or does it mean that economic survey is only for those who know such concepts? Or does it convey that the economy is in safe hands now, run by competent economists? One can only wonder. The rest of the post will hover around theoretical explanations and policy suggestions provided in chapter 2. Very often, the proposal outlined below are seen as emnating from the ‘political economy school’. It will be argued that this school is only a variant of neoclassical economics, albeit a superior one.

The chapter starts by emphasising the need to look at the foundations of macroeconomic policies, which have been neglected. The author(s) point out that an ‘enabling state’ is what India needs; a state which provides incentives through proper institutions for the individuals. That is, for policy to be effective, we “need to take people to be the way they are and then craft incentive-compatible interventions.” Under the sub heading of ‘development and distribution’, some space is devoted to the question of futures trade. It is of national concern because very often futures trade tends to make the underlying spot prices volatile. However, it is argued that “An enabling Government takes view that if we cannot establish a connection between the existence of futures trading and inflation in spot prices, we should allow futures trade.” The literature contains mixed views on this issue. Perhaps, it is being suggested that since it cannot be proved conclusively, we must go for futures trade. The rationale provided to pursue futures trade is a dangerous trend. For, economics is unlike sciences where laboratory experiments can be carried out. In any case, what is the percentage of people who invest in futures trade? And what is the percentage of Indian farmers?

Trickle down effect is said to have taken place in India through injection of demand to the poor through increases in budgetary allocations for anti-poverty programmes. The firming up or increase in prices of food items is presented as evidence for income increases of the poor. This piece of evidence is wrought with methodological as well as conceptual difficulties. Hence, it cannot be argued with such certainty that incomes of the poor have risen. For, if the prices of food items have gone up, their real wage or purchasing power must necessarily be reduced. In effect, there might not have been any notable improvement.

Subsidies are considered essential for India. However, price controls are seen as distortionary and also they result in high levels of corruption. Therefore, it is pointed out that subsidies should take the form of ‘coupons’. This achieves two objectives. (1) Prices are left to the market and (2) Individuals have more choice. Both are hallmarks of neoclassical as well as neoliberal thinking. Hence, the need for Unique Identification (UID) system for improving information. It is argued that the state should not tamper with the ‘preferences’ of the subsidy reciever. Because “modern behavioural economics reminds us that there are situations where individuals act against their own interests because of lack of self-control or inconsistencies in their inter-temporal preferences, and so some pateranlistic interventions can be good for them.” This result cannot be directly imported to a macroeconomic setting, owing to differences in objectives and also, the sum of parts may be more or less than the whole (fallacy of composition).

Apart from such proposals, foreign direct investment (FDI) in the textile and clothing sector is favoured as they “can help modernize this industry and aid its integration to the global textile market.” The introduction of powerlooms have rendered many weavers jobless and most of them have become migrant construction workers. When any sector gains more importance than those employed in that sector, it is a sign that the objective of policy makers is plain ‘numerical growth’ and not employment!

The end of the chapter contains a discussion on ‘social norms, culture and development’ which points out that standard economics has not paid much attention to social and cultural factors. And that game theory and behavioural economics “is begining to give us some insights into the formation of customs and behaviour.” It is argued that though such “phychological and sociological determinants” may not effect short-term economic outcomes, they do affect medium-term and long-term outcomes.

In the following manner, this ‘political economy school’ explains economic issues through concepts such as ineffeciency, information asymmetry, bureacracy and corruption, inventives, incomplete contracts, etc. This school of thought should not be confused with Marxian or Sraffian political economy. This chapter is testimony to the fact that economists believe that economics is a science which has testable propositions and that they result in conclusive results. For the authors hail behavioural economics as though it is a new branch of economics which is the ‘saviour’ of economics. More dangerous is some of the causal connections made in the chapter, as they are not based on any logically consistent theory nor are they borne out of experience. The ‘micro-foundations’ of the economic survey definitely needs a rethinking!

The research output of experimental economics has been showing a marked increase in the recent past. This post provides a few insights regarding the works of the experimental economists. As Shyam Sunder writes, there are three streams within experimental economics: (1) macro stream to examine the properties of social structures, (2) micro stream to examine the behavior of individuals, and (3) agent stream to explore the links between the micro and macro phenomena using computer simulations.[Sunder 2007] At the first look, experimental economics seems capable of handling the micro stream as well as the agent stream.

The following image shows how laboratory data is presented for a double auction. (Retrieved from http://veconlab.econ.virginia.edu/htm_small/da_06_small.png )

It is believed that Edward Chamberlin conducted the first experiment in economics. Chamberlin examined market conditions in his classroom in a controlled atmosphere, whose results deviated from the prevalent Walrasian conclusions. The rationale of experimental economics is that theory/models suggest general tendencies among the variables of interest. The strength of the general tendency is not provided by theory. In other words, theory cannot tell us about its explanatory power. This is where experimental economics makes its contribution. Also, this is the reason why one carries out field surveys and why econometricians look for a high R-square.

Initially, experimental economics seemed to be aping the sciences to a large extent. However, after reading Sunder’s account, I am begining to get convinced about its potential in understanding aggregate economic behaviour. Sunder wonders how we can study social beings by completely negating free will – that is, by treating it as a science. The other option is to highlight the heterogeneity of human behaviour and refuse to come up with general tendencies. As he writes:

“Hence we see the dilemma of social sciences. Do we abandon free will, personal responsibility, and special human identity; and treat humans like other objects of science? That is, drop the “social” qualifier, and become a plain
vanilla science? Or, do we drop the “science,” abandon the search for universal laws, embrace human free will and unending variation of behavior, and join the humanities? Either way, there will be no social science left. Is there a place where we can keep the “social” and the “science” together?”

Advances in computer technology assists economists working on aggregate economic variables. This is done by conducting computer simulations. The model can be taken from any theory – Marxian, Walrasian, Ricardian, Keynesian, etc – and specific behavioural rules can be assigned so as to arrive at some conclusions. But what is to be remembered is that, these computer simulations are tools which assist the policy maker and are not substitutes for theory. It must be noted that when assigning behavioural restrictions, we are negating the free will of the individual economic agents. As economists, we are used to making such an assumption – utility maximization, bounded rationality, tit-for-tat strategy, satisficing, reciprocative behaviour are all aspects of an individual’s behaviour.

To conclude, experimental economics offers economics the following benefits. Firstly, it provides data for verifying/falsifying a particular hypothesis. Secondly, through computer simulations, aggregate economic behaviour can be replicated to a limited extent. And lastly, experimental economics provides a strong flavour of science to economics.

Reference

Sunder, Shyam (2007) ‘Determinants of economic interaction: behavior or structure’, Journal of Economic Interaction and Coordination.