Utility theory — an empty tautology

4 April, 2016 at 20:18 | Posted in Economics | 1 Comment

d40a9a39952ab3304e61b5fcef07ff5c_400x400In 1938 Paul Samuelson offered a replacement for the then accepted theory of utility. The cardinal utility theory had been discarded a couple of years earlier, but according to Samuelson, the ordinalist revision of utility theory was not drastic enough. One ought to analyze the consumer’s behaviour without having recourse to the concept of utility at all, since this did not correspond to directly observable phenomena.

The new theory’s main feature was a consistency postulate which said ‘if an individual selects batch one over batch two, he does not at the same time select two over one.’  From this ‘perfectly clear’ postulate and the assumptions of given demand functions and that all income is spent, Samuelson could derive all the main results of ordinal utility theory (single-valuedness and homogeneity of degree zero of demand functions, and negative semi-definiteness of the substitution matrix).

In 1950 Hendrik Houthakker made an amendment to the theory assuring integrability, and by that the theory had according to Samuelson been ‘brought to a close.’ According to Houthakker, the aim of the revealed preference approach was ‘to formulate equivalent systems of axioms on preferences and on demand functions.’

But if this is all, what has revealed preference theory then achieved? In 1997 Reinhard Sippel performed experiments that he argued showed ‘a considerable number of violations of the revealed preference axioms’ and that from a descriptive point of view – as a theory of consumer behaviour – the revealed preference theory was of a very limited value.

Today it seems as though the proponents of revealed preference theory have given up the original 1938-attempt at building a theory on nothing else but observable facts, and settled instead on the 1950-version of establishing ‘logical equivalences.’

When talking of determining people’s preferences through observation, Hal Varian, for example, has ‘to assume that the preferences will remain unchanged’ and adopts ‘the convention that … the underlying preferences … are known to be strictly convex.’ He further postulates that the ‘consumer is an optimizing consumer.’ If we are ‘willing to add more assumptions about consumer preferences, we get more precise estimates about the shape of indifference curves.’ Given these assumptions, and that the observed choices satisfy the consistency postulate as amended by Houthakker, one can always construct preferences that ‘could have generated the observed choices.’ This does not, however, prove that the constructed preferences really generated the observed choices, ‘we can only show that observed behavior is not inconsistent with the statement. We can’t prove that the economic model is correct.’

Revealed preference theory tried to build a new theory and to put it in operational terms, but ended up with just giving a theory logically equivalent to the old one. As such it also shares its shortcomings of being empirically nonfalsifiable and of being based on unrestricted universal statements.

As Janos Kornai once remarked — ‘the theory is empty, tautological. The theory reduces to the statement that in period t the decision-maker chooses what he prefers … The task is to explain why he chose precisely this alternative rather than another one.’

Mainstream (neoclassical) economics doesn’t want to get involved in psychological discourse, so it basically assumes that the aims and ends of people are exogenously ‘given’ and that a fortiori preferences also are  ‘given’ and that people behave as if they were maximizing a utility function based on these ‘given’ preferences. However — what people usually do, is to base their choices on aims and ends, while their preferences are not given, but rather something that comes out of  people’s deliberations on these aims and ends in specific spatio-temporal contexts. We all make choices, but they certainly aren’t based on ‘preference rankings’ or their equivalent utility representations!



1 Comment

  1. When, oh, when are these mainstream economists going to realize that humans are not rational, optimizing automatons? Are they so hyper-rational themselves that they never make irrational, i.e., emotional decisions? Or are they so lacking in self-awareness that they are unable to recognize when their own preferences or decisions are not optimizing or rational?

    Seriously, this is something I have been unable to wrap my head around ever since I understood how pervasive this rational, utility-maximizing “representative individual” concept is in mainstream economics.

    I know my memory is not what it once was, but I don’t remember this concept being so widely accepted and heavily emphasized when I studied economics at Wharton 45 years ago (and Samuelson’s was the introductory textbook).


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