Undergraduate Economist

Perspectives of an economics student

Archive for the 'Utility' Category

Economics: The Study of Commodities

Posted by Alex M Thomas on 18th December 2010

The study of commodities has been central to economic theory. Mercantilists considered gold, a commodity to be wealth. Later economists argued that an increase in commodities, both agricultural and manufactured, implied an increase in wealth. The increase in the production of commodities is still the most widely used indicator of economic growth/progress. This indicator is none other than the real GDP. In 1985, Amartya Sen published a book titled Commodities and Capabilities. In this work, Sen challenges the dominant view in economics regarding the role of commodities, i.e. he maintained that an increase in commodities cannot be taken as the sole factor in assessing economic development. Sen emphasised the importance of examining capabilities, which subsequently led to the creating of the Human Development Index (HDI). This post discusses the rationale behind economists’ obsession with commodities. It also examines Sen’s critique of commodities and how his (Aristotelian) concept of capabilities differs from it. This post concludes by arguing for a strengthening of classical economics, which studies the production, distribution, exchange and consumption of commodities, for the considerations of ethics can be easily integrated into this approach.

Economics as a distinct form of inquiry begins with the works of Sir William Petty in the 17th century. Petty was interested in assessing the comparative wealth of England and Ireland. Some of the indicators he chose were the number of houses and population. The idea behind this being that a surplus of food results in more population and therefore more houses. Having a large population was considered to be beneficial to the state. His successor, Richard Cantillon, an economist par excellence, pointed out that wealth of a state is reflected in the quantity and nature of commodities it produces – necessities, comforts and luxuries. This brief historical excursus is to point out the nature of economic inquiry, which is essentially an analysis of quantities and prices. Examples of quantities are employment, income, exports, investment, money supply, etc. Examples of prices are WPI, interest rates, foreign exchange rate, commodity prices, share prices, etc. That is, an analysis of commodities is an examination of quantity and price at the same time. Therefore, an analysis of commodities subsumes an examination of their production, distribution, exchange and consumption. Production includes the structure and relations of production; distribution pertains to the process and mechanism through which the incomes/surplus from production is divided among its participants; exchange refers to the mode and institution through which commodities are sold; finally, consumption illuminates the channels through which consumption of commodities aid production in the next period and how production in the current period aids current consumption. Thus, classical economists such as Petty, Cantillon, Quesnay, Smith and Ricardo were interested in the theory of production, distribution and exchange of commodities. Their interest was motivated by the need to find out ways of improving the general well-being of their respective societies.

According to Sen, the kind of analysis posited above looks at opulence as the sole indicator of economic development. A shift in economic analysis came about in the 1870s with the emergence of marginal analysis, independently developed by Jevons, Walras and Menger. Terms such as utility, choice, scarcity, margins, etc made inroads into economics. In fact, standard microeconomics texts are nothing but a combination of Walrasian and Marshallian economics. In any case, the maximization of utility began to be seen as the objective of individuals, for attaining economic progress. The internal justice of free markets was imbued to this form of economic analysis. Based on utilitarian principles, the maximization of utility by individuals was seen as a way to improve human well-being and welfare. This conception of development, according to Sen, emphasised the role of utility.

Both the above mentioned analyses, according to Sen, deal with “the relation between commodities and people” (p. 1). The former approach argues for more commodities which leads to more production, which raises the incomes of the people and hence their consumption. The latter analysis points out that “more is better” and hence availability of more commodities imply more utility. The idea of “more is better” is intricately connected with their idea of economics, as a science of choice. Economics, for marginal/neoclassical economists, refers to the allocation of scarce resources amongst alternative uses, as Lionel Robbins points out. For Sen, both these analyses are limited, since they do not address the heterogeneity in the capabilities of different people, which leads to “a confounding of the state of a person with the extent of his or her possessions” (p. 16). It is precisely this argument of Sen developed in his 1985 book which widened the scope of mainstream economics. I write mainstream economics because for classical economists, economics or political economy formed only one way of looking at growth/progress/development. For classical economists, as pointed out earlier, an analysis of production included the state or condition of the producer. The best example of this form of theorising can be found in Marx, the last of the early classical economists. However, with the advent of marginal analysis, the analyses of the structure of production took a backseat. The sphere of exchange came to the forefront and along with it the explanation of the formation of all kinds of prices and quantities through the apparatus of demand & supply.

It is interesting to note that the idea of capabilities has been intrinsic to classical economics. As mentioned earlier, an increase in the production of commodities translates into an increase in income generated. In contrast with neoclassical economics, the economic processes is visualised in a circular way as opposed to a one-way street. One needs to look into the structure of production to find out to whom (which class) this increase in income accrues (theory of distribution). However, the manner in which Sen develops his capabilities approach is rooted in mainstream/neoclassical economics – via the sub-domain of welfare economics (See Benicourt 2002 and Omkarnath 2007). Although, Sen deserves credit for bringing back humanitarian concerns into the discourse of neoclassical economics. Omkarnath further points out that the capabilities approach rooted in the Walrasian tradition is static in nature, for it mainly concentrates on the formation of capabilities. Whereas, classical economics has numerous insights on the relation between capabilities and commodities. This sort of analysis calls for a careful examination of the structure of production, distribution and exchange present in various economies in the classical political economy tradition, which has more scope for including social, cultural and political factors as well as ethical concerns.

References

Benicourt, E (2002), “Is Amartya Sen a Post-Autistic Economist?”, post-autistic economics review, issue no. 15, September 4, 2002, article 4. http://www.paecon.net/PAEReview/issue15/Benicourt15.htm

Omkarnath, G (2007), “The Formation of Capabilities”, Indian Journal of Human Development, Vol. 1, No. 2, pp. 389-399.

Sen, Amartya (1985) [1999], Commodities and Capabilities, Oxford University Press: New Delhi.

Tags: , , , , ,
Posted in Adam Smith, Classical Political Economy, David Ricardo, Development Economics, Economic Philosophy, Economics, Francois Quesnay, GDP, Karl Marx, Neoclassical Economics, Political Economy, Prices, Richard Cantillon, Utility | 4 Comments »

Labour, Scarcity and Techniques of Production

Posted by Alex M Thomas on 20th August 2008

Value – is of utmost importance to all paradigms in Economics (Neo-classical, Classical Political Economy, Austrian Economics, Marxian Economics, etc) because the theory of value is the fundamental proposition or the foundation on which subsequent theories are built. Therefore, it is crucial to understand the various theories of value.

The problem of value has different features. The aim could be to find the source of value, a standard of value for inter-temporal comparisons between and across countries and determination of exchange values in theoretical problems.

Through an example pertaining to ‘value’, this post tries to bring out the distinction between the Neo-classical and Classical paradigm in terms of the source of value. As students of economics, all of us have come across the Diamond-Water paradox. This paradox is a commonplace in economic literature, even before Adam Smith. This is how Smith refers to the paradox:

The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be held in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

For the classical economists, value of a commodity means the value in exchange. And prices of commodities are believed to reflect its ‘value’. Value in exchange is determined by the conditions of reproduction of the economic system. The economic system is one where a number of firms using labour, land and capital (machinery, tools, etc), produce commodities (goods produced with the intention of selling them) by using commodities produced by the economic system (the firms within it). The conditions of reproduction would include the technology available (which would tells us in what proportions the labour and capital need to be mixed; in neo classical terminology, it would give a fixed proportions production function) Moreover, the classical economists did not consider value in use as a measurable quantity.

Before the ‘marginalist revolution’, utility had an objective sense as the capacity of a good to satisfy some need, and not as the subjective evaluation on the part of one or more individuals. It is worth noting that, in a capitalist economy a good or service is produced only because it can be sold. According to Marx, it is commodity production which forms the fundamental tenet of Capitalism. So, any commodity in a capitalistic economy does have utility. To clarify my argument, let me modify the definition of a commodity. A commodity is a good or service which is produced or offered only because it has a use value. Rather, it can be put for sale only if it has utility for someone or the other. The market does not produce commodities which has no demand or that which has no use/utility for any one.

Thus, it is clear that in a capitalistic economy (all economics theories, namely neoclassical, classical and Marxian tried to understand the working of a capitalist mode of production) the proposition that a commodity has a use value is a truism. So, because all commodities had a use value which they believed could not be measured, the value of a commodity was seen as the exchange value of it.

Since, labour was considered to occupy a central position in the economy, Adam Smith put forth the view that ‘labour commanded’ could be used as a standard to measure exchange value. In Marx, it takes the form of ‘labour embodied’ which then gives rise to the labour theory of value. For Marx, it is labour which provides value to the commodity by engaging in the production of that particular commodity.

Thus when the paradox is viewed through the classical and Marxian lens, it seems as if the paradox is only an illusion. The production of diamond is a costly affair and thereby requires a lot of labour (in today’s world, a lot of capital as well) due to which the value (exchange value) of diamond is high and thereby it commands a high price. More the labour needed for producing a commodity, more will be its value. So, because of the higher production costs, diamond is priced high.

For the neoclassical economists, the price of a commodity is determined by its marginal utility. Marginal utility is based on a subjective theory of value. Let me put forth two snippets from neoclassical economics as to how the paradox is resolved.

The more there is of a commodity, the less the relative desirability of its last little unit becomes, even though its total usefulness grows as we get more of the commodity. So, it is obvious why a large amount of water has a low price.” – Paul Samuleson, the first American to receive a Nobel Prize in Economics.

In the blogosphere, I came across this piece from Michael Stastny, who blogs at Mahalnobis.

A better answer to the paradox why diamonds are more expensive than water would be that since water is so plentyful, the marginal utility (= the derivative of U(x) with respect to x, i.e. (approx.) the extra satisfaction of wants and needs obtained from consuming one additional unit of good) of water is is relatively low. An extra liter of water provides very little additional satisfaction. To the contrast, diamonds are very scarce and the marginal utility is therefor relatively high.

The study of economics is aimed at discovering the laws prevailing in the economic sphere. This helps in understanding the inter relationships within an economy. This further helps in policy purposes, by trying to increase investment rates, saving rates, GDP, etc.

The reasons provided for the paradox above assume that prices of commodities arise from their scarcity. Capitalism ensures a constant supply of the commodities which have utility (objective or subjective). It is to understand how prices come about, that economists theorize on values. For neoclassical economics, prices are indices of scarcity.

Let me illustrate the ignorance of neoclassical economics with an example. In a functioning economy, suppose an inventor discovers/invents a new product/commodity – say a vehicle that runs on air. So, at this point of time, there is only one firm supplying this commodity. It is extremely scarce and according to neoclassical theory, it is rational for the producer to sell the first vehicle at any price because it has the highest value by being the sole product in the market.

So, when the first vehicle is on sale, the demand outstrips the supply. According to the neoclassical theories, the capitalist can ask for a higher price in such circumstances. I conclude by asking: is that how commodities are priced? Are such prices ethical? Isn’t it the techniques of production along with the wage rate and profit rate that governs the prices of commodities?

References

1) The Wealth of Ideas: A History of Economic Thought, Alessandro Roncaglia, 2005.

2) Das Kapital, Volume 1, Karl Marx.

3) Economics, 11th edition, Paul A Samuelson, 1980.

Posted in Adam Smith, Classical Political Economy, Economic history, Economic Thought, Economics, Karl Marx, Neoclassical Economics, Utility, Value | 2 Comments »

On Neo-classical economics

Posted by Alex M Thomas on 7th September 2007

This post is the first in the series- On Neoclassical Economics. This series attempts to look at the basic concepts of Neoclassicalism or Marginalism. The concepts that this series will cover are that of man being rational, measurement of utility, equilibrium from demand and supply, Micro and Macro economics and notion of perfect competition.

Remind yourself that what we (mostly) see in textbooks is Neoclassical economics (In India). Is there another approach to Economics which these textbooks fail to talk about? The answer is yes. It is known as ‘Classical Political Economy’.

Classical Political Economy

The concern of the classical economists from Adam Smith to David Ricardo was the laws governing the emerging capitalist economy, characterized by wage labour, an increasingly sophisticated division of labour, the coordination of economic activities via a system of interdependent markets in which transactions are mediated through money, and rapid technical, organizational and institutional change. In short, they were concerned with an economic system in motion. [Kurz and Salvadori 1998]

This approach does not break economics into monetary, fiscal, international trade, microeconomics, macroeconomics etc. Nowadays, economics has got lot many divisions and specialties, that I feel the essence is getting compromised. [Thomas 2006] Classical Political Economy does not make such compartments like the ‘mainstream economics’ and is also dynamic in nature.

Neoclassical economics began as a project to fashion an economic model in the image of Newtonian mechanics, one in which economic agents could be treated as if they were particles obeying mechanical laws, and all of whose behaviour could, in principle, be described simultaneously by a solvable system of equations. [www.paecon.net ]

This post delves into the origin and the importance utility enjoys in Microeconomics aka ‘the pet of Neoclassicalists‘.

Economists are subject to many vices, and one of them has been to talk about ‘utility’, which is a quantitative conception that there is no known way of measuring. [Robinson 1979] Still, hours and hours are dedicated to the task of measuring Utility and ‘Marginal’ Utility in colleges and universities. It forms the basis of Microeconomics and also helps in bringing more mathematics into the realm of economics.

Bernard Guerrien writes in Issue 12 of the Post-Autistic Economics Review that “The French students’ movement against autism in economics started with a revolt against the disproportionate importance of microeconomics in economics teaching. The students complained that nobody had really proved to them that microeconomics was of any use; what is the interest of going through “micro1”, “micro2”, “micro3”, etc., using lots of mathematics to speak of fictitious households, fictitious enterprises and fictitious markets?”

Can economic policies be made based on such ‘fictitious’ measurements? Is economics a policy science or an intellectual game? One becomes a skeptic when wondering about why ‘Microeconomics’ has come to dominate economics learning. Is it to make economics more mathematical?

A digression: Economy

The concept of the ‘economy’ is of utmost importance in this regard. Does the ‘economy’ occupy a separate existence from that of the community and the state? Very often, the headlines in the media say so, but it is not so. And economics is not tantamount to money.

According to C. T. Kurien, Economy is a structure of relationships among a group of people, in terms of the manner in which they exercise control over resources, use resources and labour in the production of goods, and define and settle the claims of the members over what is produced, emphasising that while the economy is concerned with goods and services, it should be recognised essentially as a set of social relationships.

The economy consists of two realms, namely the community and the market. Community refers to real, on-the-ground associations and to imagined solidarities that people experience. [Gudeman 2001] Gudeman goes on to say that ‘Neoclassical economics focuses on one value domain, the market, which is modified as a separate sphere making up the whole of economy in which all goods are priced and available for exchange.’

On Utilitarianism

Bentham played a crucial role in the development of ‘utility measurement’. He proposed the ‘felicific calculus’, namely the quantitative evaluation and the algebraic summation of pleasures and pains stemming as consequences from any given course of action. ‘Good’ is whatever gives as its result an algebraically positive felicific magnitude, and hence increases the ‘amount of happiness’ within human societies; ‘bad’ is whatever gives as its result a negative quantity, and as a consequence decreases the amount of social happiness. [Roncaglia 1999]

But, Mill in his Utilitarianism (1987) criticizes this notion of measurement of utility by stating that ‘Utility is an uncertain standard, which every different person interprets differently, and even ‘in the mind of one and the same individual, justice is not some one rule, principle, or maxim, but many.’

If there is an intellectual field where the utilitarian attitude-namely, looking at the consequences of human actions-dominates, to the point of being identified with the scientific attitude tout court, this is economics” [Roncaglia 1999](Italics added)

Utility, when taught to students, appears very logical and thus is easily comprehended and imbibed. Of course, no individual would do any activity if it didn’t give him or her pleasure or rather, ‘utility’. As a philosophical concept, it does make sense. But when it is introduced into the realm of economics, it fails miserably. The demand function which is built on utility along with the supply is what determines the equilibrium price and quantity in neoclassical economics. But if one stops to think and to try and relate it to the real world, one would fail. Think of how prices are determined; and are prices based on demand and supply functions?

Conclusions

What has neoclassical theory taught us? That individuals do what they do because they get ‘utility’ out of it? And that this helps in calculating the demand of an economy which further helps in the determination of prices? Does it tell us anything about the working of the economy?

References

1) Kurz, H and Salvadori, N (edited), The Elgar companion to classical economics (A-K), 1998.
2) Robinson, Joan, Collected Economic Papers, 1979.
3) Kurien, C T, Rethinking Economics, 1995.
4) Gudeman, Stephen, The anthropology of economy, 2001.
5) Thomas, A M, Undergraduate Economist, The fellowship of economics, 2007.

Posted in Classical Political Economy, Neoclassical Economics, Utility | 10 Comments »