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An alternative interpretation of the household’s optimization problem
An Alternative Interpretation of the Household’s Optimization Problem DAGMAR RAJAGOPAL* Ryerson Polytechnic University
This note is an invitation to academic economists to broaden the way in which we present and interpret the household’s optimization problem to our students in microeconomics courses. It suggests that while maximizing utility subject to a budget constraint is mathematically equivalent to minimizing expenditures for a given target level of utility, the psychological implications of these alternative presentations of the optimization problem may be quite different. Instead of influencing the attitude and consumption behavior of our students by explaining only one of these approaches, we may want to expose them to both interpretations and let them choose the one they find more appropriate, hopefully after giving careful thought to both of them.
Standard theory of the household tells us that rational consumers behave as if they maximized their utility or satisfaction, subject to the constraint imposed by their income. In textbooks and monographs alike, it is usually assumed that the consumer’s level of satisfaction increases with the amounts of goods and services bought. Downward sloping indifference curves imply the assumption that more is better, that the consumer is not satiated.1 For readers who are not economists, it may be helpful to explain that so-called indifference curves connect all combinations of two goods such as food and clothing which give the same level of satisfaction. They can be thought of as “equal-satisfaction lines,” and they derive their name from the fact that consumers are indifferent between all the combinations of the two goods which give them the same level of satisfaction. If we * Direct all correspondence to: Dagmar Rajagopal, Department of Economics, Ryerson Polytechnic University, 350 Victoria Street, Toronto, Canada, M5B 2K3. Telephone: (416) 979-5000, ext. 7320. E-mail: [email protected]. The Social Science Journal, Volume 37, Number 4, pages 647– 651. Copyright © 2000 by Elsevier Science Inc. All rights of reproduction in any form reserved. ISSN: 0362-3319.
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assume that more is always better, then having more of both goods has to increase the consumer’s level of satisfaction. Satisfaction can remain constant only if consumers give up some food in return for more clothing, or the other way around. Therefore, indifference curves have to slope downward if we assume that more is better. Two questions can be asked about the assumption of nonsatiation: First, is it correct in the sense of positive economics, does it describe the behavior of consumers correctly? Second, is the assumption that more is better right in the sense of normative economics, is it desirable for consumers to behave as if more were better most of the time? Some people believe that affluent consumers ought to ask themselves how much is enough, instead of wanting more and more. Should economists routinely imply that more is necessarily better by the way in which we teach the theory of the household?
POSITIVE ECONOMICS Does the assumption of nonsatiation correctly describe the attitude of consumers? Ultimately the answer to this question has to be provided by empirical studies. But even anecdotal evidence can serve to make us question whether the assumption of nonsatiation is as universally applicable as the standard theory of the household would have us believe. We all give our students examples along the lines that even chocoholics can only eat so much chocolate during a given time period, after which they become satiated. But then we go on to draw downward sloping indifference curves anyway, as if these examples were the proverbial exceptions which prove the rule. Are such examples of satiation indeed isolated cases, or is satiation perhaps much more common than we realize? For example, do people really derive more satisfaction the more electricity or natural gas or heating fuel they consume? If the consumption of more energy were better than that of less, why don’t we leave all our windows wide open night and day and turn up the heating or air conditioning? Even before the oil price shock of the early 1970s few people behaved in this way. Is the reason, perhaps, that the consumption of energy does not in itself provide us with satisfaction? Does it not make sense to assume instead that people obtain satisfaction from a certain target level of comfort, neither too hot nor too cold, and that they aim to achieve this target level of physical comfort at the lowest possible expenditure? In other words, we derive satisfaction from living and working in a comfortable room, not from consuming energy nor, for that matter, from installing home insulation and wearing sweaters. The consumption of energy, warm clothing and insulating material is not an end in itself, but merely a means toward the end of feeling physically comfortable. Similarly, if we consume more electricity to obtain hot water because one of our faucets is dripping, or because our water tank is poorly insulated, does our satisfaction increase with this higher consumption of electricity? Is it not more reasonable to assume that we require a certain amount of hot water, and that we try to obtain it at the lowest possible expenditures on electricity, repair of the plumbing system, insulating material for the hot water tank, and so forth? For many goods it may be quite realistic to replace the assumption of maximizing behavior on the part of consumers by the assumption that people attempt to strike the right balance between two undesirable extremes: Being well fed involves a balance between starving and overeating. Similarly, being physically comfortable means finding the happy
Intrepretation of the Household’s Optimization Problem
649
medium between shivering with cold and perspiring with heat. In both these examples the consumer’s target level of comfort is found by striking a balance between two extremes, not by trying to buy as much as the consumer is able to afford. Given their preferred balance between two extremes, consumers then try to achieve their target level of satisfaction at the lowest possible expenditure on goods and services. Certainly those people who believe in, and act according to, the modern three R’s “reduce, reuse, and recycle” neither assume that, nor behave as if more were necessarily better. They ask themselves instead how much is enough, and try to achieve a given level of satisfaction by buying as few goods and services as possible. In other words, for some consumers and for many goods and services it may well be appropriate to describe the consumer’s decision-making process as one of minimizing expenditures for achieving a target level of comfort or satisfaction. From a mathematical point of view it does not matter, of course, whether we state the household’s choice problem as one of maximizing satisfaction subject to a given level of income, or whether we describe the consumer as minimizing expenditures for a target level of comfort or satisfaction. These are two mathematically equivalent ways of describing the household’s decision-making problem. Psychologically, however, the two formulations may well reflect very different attitudes. The behavior of consumers who try to maximize the amount of goods and services purchased for a given budget, may not be the same as the behavior of people who minimize the expenditures with which they achieve a particular level of satisfaction. The former are likely to act as if they believe that more is always better, while the latter may ask themselves, instead, how much is enough. In the framework of expenditure minimization, education to promote the conservation of nonrenewable resources can be interpreted as an attempt to make consumers more X-efficient2 by reducing waste, so that households are able to achieve their present level of satisfaction while buying fewer goods and services. An example of this type of effort to reduce the consumption of electricity was Ontario Hydro’s “off-campaign” a few years ago. [Ontario Hydro is the name of the publicly owned electric utility of the Province of Ontario, Canada.] The company used advertisements to induce people to turn off their light switches and taps when they were not using electricity or hot water. Ontario Hydro’s commercials were not trying to persuade households to reduce their level of satisfaction. They were an attempt, rather, at making people achieve their current level of satisfaction while consuming less electricity.
NORMATIVE ECONOMICS Even if most consumers actually behaved as if more were always better, is it desirable for people to act in this way? It can be argued that the pattern of consumption implied by the assumption of nonsatiation is no longer sustainable, given its high environmental costs. This point was made by, for example, Herman E. Daly (1992), Alan Durning (1991), and Donella H. Meadows, Dennis L. Meadows, and Jørgen Randers (1992). The latter authors comment that “the cultural expectations and practices . . . that associate social status with material accumulation, and that define human goals in terms of getting more rather than having enough”3 are a major factor in promoting a level of consumption that is not sustainable in the long run. It is not the purpose of this note to summarize the arguments
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of authors such as Daly, Durning, and Meadows, Meadows and Randers, why consumption cannot continue to grow forever in affluent countries. For the sake of the argument, let us assume that it were desirable to reduce the harmful effects of economic activity on the natural environment of our planet. In that case, it would be desirable for consumers to think in terms of minimizing their expenditures subject to a target level of satisfaction, instead of maximizing their level of utility for a given amount of income.
CONCLUSION By teaching that consumers maximize their utility subject to the budget constraint, we imply that in the absence of this constraint, there would be no limit to how much people want to consume, that more is always better. In the process we end up reinforcing the attitudes with which many of our students enter the classroom. If we taught, instead, that consumers have a target level of satisfaction that they try to reach at minimum expenditure, we would imply that it is possible to have enough goods and services, or even that less can be better. By doing so, we might cause some of our students to question their attitude that more is always better, and we would reinforce the behavior of those who already ask themselves how much is enough, in the interest of the environment, and of sharing the world’s scarce resources more equitably between affluent and poor countries. We cannot help influencing the attitude and the consumption behavior of the students we teach, even if we never explicitly leave the realm of supposedly value-free positive economics. In the words of Daly (1992): “The theory by which we try to understand our economic behavior cannot help but be an element in determining that behavior.”4 There is a third possibility, however: By explaining expenditure minimization as well as utility maximization to the students, we would avoid indoctrinating them one way or the other. This would allow the students themselves to choose that formulation of the consumer’s optimization problem which they find more appropriate, hopefully after giving careful thought to both interpretations.
NOTES 1. 2. 3. 4.
For example, Lawrence A. Boland (1992, p. 186); Angus Deaton and John Muellbauer (1980, p. 28); Robert H. Frank (1997, p. 74). On the concept of “X-efficiency,” see Harvey Leibenstein (1966). Meadows, Meadows, and Randers (1992, p. 192). Daly (1992, p. 41).
REFERENCES Boland, L. A. (1992). The Principles of Economics. Some Lies My Teachers Told Me. London: Routledge. Daly, H. E. (1992). Steady-State Economics, 2nd ed. London: Earthscan Publ. Ltd. Deaton, A. and J. Muellbauer. (1980). Economics and Consumer Behavior. Cambridge: Cambridge University Press.
Intrepretation of the Household’s Optimization Problem
651
Durning, A. (1991). “How Much Is Enough?” Technology Review, vol. 94, no. 4 (May/June), pp. 57– 64. Frank, R. H. (1997). Microeconomics and Behavior, 3rd ed, New York: McGraw-Hill. Leibenstein, H. (1966). Allocative Efficiency vs. ‘X-Efficiency’. American Economic Review, 56: 392– 415. Meadows, D. H., D. L. Meadows, and J. Randers. (1992) Beyond the Limits, Global Collapse or a Sustainable Future. London: Earthscan Publications Ltd.
This note is an invitation to academic economists to broaden the way in which we present and interpret the household’s optimization problem to our students in microeconomics courses. It suggests that while maximizing utility subject to a budget constraint is mathematically equivalent to minimizing expenditures for a given target level of utility, the psychological implications of these alternative presentations of the optimization problem may be quite different. Instead of influencing the attitude and consumption behavior of our students by explaining only one of these approaches, we may want to expose them to both interpretations and let them choose the one they find more appropriate, hopefully after giving careful thought to both of them.
Standard theory of the household tells us that rational consumers behave as if they maximized their utility or satisfaction, subject to the constraint imposed by their income. In textbooks and monographs alike, it is usually assumed that the consumer’s level of satisfaction increases with the amounts of goods and services bought. Downward sloping indifference curves imply the assumption that more is better, that the consumer is not satiated.1 For readers who are not economists, it may be helpful to explain that so-called indifference curves connect all combinations of two goods such as food and clothing which give the same level of satisfaction. They can be thought of as “equal-satisfaction lines,” and they derive their name from the fact that consumers are indifferent between all the combinations of the two goods which give them the same level of satisfaction. If we * Direct all correspondence to: Dagmar Rajagopal, Department of Economics, Ryerson Polytechnic University, 350 Victoria Street, Toronto, Canada, M5B 2K3. Telephone: (416) 979-5000, ext. 7320. E-mail: [email protected]. The Social Science Journal, Volume 37, Number 4, pages 647– 651. Copyright © 2000 by Elsevier Science Inc. All rights of reproduction in any form reserved. ISSN: 0362-3319.
648
THE SOCIAL SCIENCE JOURNAL Vol. 37/No. 4/2000
assume that more is always better, then having more of both goods has to increase the consumer’s level of satisfaction. Satisfaction can remain constant only if consumers give up some food in return for more clothing, or the other way around. Therefore, indifference curves have to slope downward if we assume that more is better. Two questions can be asked about the assumption of nonsatiation: First, is it correct in the sense of positive economics, does it describe the behavior of consumers correctly? Second, is the assumption that more is better right in the sense of normative economics, is it desirable for consumers to behave as if more were better most of the time? Some people believe that affluent consumers ought to ask themselves how much is enough, instead of wanting more and more. Should economists routinely imply that more is necessarily better by the way in which we teach the theory of the household?
POSITIVE ECONOMICS Does the assumption of nonsatiation correctly describe the attitude of consumers? Ultimately the answer to this question has to be provided by empirical studies. But even anecdotal evidence can serve to make us question whether the assumption of nonsatiation is as universally applicable as the standard theory of the household would have us believe. We all give our students examples along the lines that even chocoholics can only eat so much chocolate during a given time period, after which they become satiated. But then we go on to draw downward sloping indifference curves anyway, as if these examples were the proverbial exceptions which prove the rule. Are such examples of satiation indeed isolated cases, or is satiation perhaps much more common than we realize? For example, do people really derive more satisfaction the more electricity or natural gas or heating fuel they consume? If the consumption of more energy were better than that of less, why don’t we leave all our windows wide open night and day and turn up the heating or air conditioning? Even before the oil price shock of the early 1970s few people behaved in this way. Is the reason, perhaps, that the consumption of energy does not in itself provide us with satisfaction? Does it not make sense to assume instead that people obtain satisfaction from a certain target level of comfort, neither too hot nor too cold, and that they aim to achieve this target level of physical comfort at the lowest possible expenditure? In other words, we derive satisfaction from living and working in a comfortable room, not from consuming energy nor, for that matter, from installing home insulation and wearing sweaters. The consumption of energy, warm clothing and insulating material is not an end in itself, but merely a means toward the end of feeling physically comfortable. Similarly, if we consume more electricity to obtain hot water because one of our faucets is dripping, or because our water tank is poorly insulated, does our satisfaction increase with this higher consumption of electricity? Is it not more reasonable to assume that we require a certain amount of hot water, and that we try to obtain it at the lowest possible expenditures on electricity, repair of the plumbing system, insulating material for the hot water tank, and so forth? For many goods it may be quite realistic to replace the assumption of maximizing behavior on the part of consumers by the assumption that people attempt to strike the right balance between two undesirable extremes: Being well fed involves a balance between starving and overeating. Similarly, being physically comfortable means finding the happy
Intrepretation of the Household’s Optimization Problem
649
medium between shivering with cold and perspiring with heat. In both these examples the consumer’s target level of comfort is found by striking a balance between two extremes, not by trying to buy as much as the consumer is able to afford. Given their preferred balance between two extremes, consumers then try to achieve their target level of satisfaction at the lowest possible expenditure on goods and services. Certainly those people who believe in, and act according to, the modern three R’s “reduce, reuse, and recycle” neither assume that, nor behave as if more were necessarily better. They ask themselves instead how much is enough, and try to achieve a given level of satisfaction by buying as few goods and services as possible. In other words, for some consumers and for many goods and services it may well be appropriate to describe the consumer’s decision-making process as one of minimizing expenditures for achieving a target level of comfort or satisfaction. From a mathematical point of view it does not matter, of course, whether we state the household’s choice problem as one of maximizing satisfaction subject to a given level of income, or whether we describe the consumer as minimizing expenditures for a target level of comfort or satisfaction. These are two mathematically equivalent ways of describing the household’s decision-making problem. Psychologically, however, the two formulations may well reflect very different attitudes. The behavior of consumers who try to maximize the amount of goods and services purchased for a given budget, may not be the same as the behavior of people who minimize the expenditures with which they achieve a particular level of satisfaction. The former are likely to act as if they believe that more is always better, while the latter may ask themselves, instead, how much is enough. In the framework of expenditure minimization, education to promote the conservation of nonrenewable resources can be interpreted as an attempt to make consumers more X-efficient2 by reducing waste, so that households are able to achieve their present level of satisfaction while buying fewer goods and services. An example of this type of effort to reduce the consumption of electricity was Ontario Hydro’s “off-campaign” a few years ago. [Ontario Hydro is the name of the publicly owned electric utility of the Province of Ontario, Canada.] The company used advertisements to induce people to turn off their light switches and taps when they were not using electricity or hot water. Ontario Hydro’s commercials were not trying to persuade households to reduce their level of satisfaction. They were an attempt, rather, at making people achieve their current level of satisfaction while consuming less electricity.
NORMATIVE ECONOMICS Even if most consumers actually behaved as if more were always better, is it desirable for people to act in this way? It can be argued that the pattern of consumption implied by the assumption of nonsatiation is no longer sustainable, given its high environmental costs. This point was made by, for example, Herman E. Daly (1992), Alan Durning (1991), and Donella H. Meadows, Dennis L. Meadows, and Jørgen Randers (1992). The latter authors comment that “the cultural expectations and practices . . . that associate social status with material accumulation, and that define human goals in terms of getting more rather than having enough”3 are a major factor in promoting a level of consumption that is not sustainable in the long run. It is not the purpose of this note to summarize the arguments
650
THE SOCIAL SCIENCE JOURNAL Vol. 37/No. 4/2000
of authors such as Daly, Durning, and Meadows, Meadows and Randers, why consumption cannot continue to grow forever in affluent countries. For the sake of the argument, let us assume that it were desirable to reduce the harmful effects of economic activity on the natural environment of our planet. In that case, it would be desirable for consumers to think in terms of minimizing their expenditures subject to a target level of satisfaction, instead of maximizing their level of utility for a given amount of income.
CONCLUSION By teaching that consumers maximize their utility subject to the budget constraint, we imply that in the absence of this constraint, there would be no limit to how much people want to consume, that more is always better. In the process we end up reinforcing the attitudes with which many of our students enter the classroom. If we taught, instead, that consumers have a target level of satisfaction that they try to reach at minimum expenditure, we would imply that it is possible to have enough goods and services, or even that less can be better. By doing so, we might cause some of our students to question their attitude that more is always better, and we would reinforce the behavior of those who already ask themselves how much is enough, in the interest of the environment, and of sharing the world’s scarce resources more equitably between affluent and poor countries. We cannot help influencing the attitude and the consumption behavior of the students we teach, even if we never explicitly leave the realm of supposedly value-free positive economics. In the words of Daly (1992): “The theory by which we try to understand our economic behavior cannot help but be an element in determining that behavior.”4 There is a third possibility, however: By explaining expenditure minimization as well as utility maximization to the students, we would avoid indoctrinating them one way or the other. This would allow the students themselves to choose that formulation of the consumer’s optimization problem which they find more appropriate, hopefully after giving careful thought to both interpretations.
NOTES 1. 2. 3. 4.
For example, Lawrence A. Boland (1992, p. 186); Angus Deaton and John Muellbauer (1980, p. 28); Robert H. Frank (1997, p. 74). On the concept of “X-efficiency,” see Harvey Leibenstein (1966). Meadows, Meadows, and Randers (1992, p. 192). Daly (1992, p. 41).
REFERENCES Boland, L. A. (1992). The Principles of Economics. Some Lies My Teachers Told Me. London: Routledge. Daly, H. E. (1992). Steady-State Economics, 2nd ed. London: Earthscan Publ. Ltd. Deaton, A. and J. Muellbauer. (1980). Economics and Consumer Behavior. Cambridge: Cambridge University Press.
Intrepretation of the Household’s Optimization Problem
651
Durning, A. (1991). “How Much Is Enough?” Technology Review, vol. 94, no. 4 (May/June), pp. 57– 64. Frank, R. H. (1997). Microeconomics and Behavior, 3rd ed, New York: McGraw-Hill. Leibenstein, H. (1966). Allocative Efficiency vs. ‘X-Efficiency’. American Economic Review, 56: 392– 415. Meadows, D. H., D. L. Meadows, and J. Randers. (1992) Beyond the Limits, Global Collapse or a Sustainable Future. London: Earthscan Publications Ltd.