Friday, July 27, 2012

Different Individuals’ Preferences Can’t Be Combined

If preferences are subjective to each individual, and cannot even be measured or quantified for each individual, then obviously it would make no sense at all to try to combine or aggregate individual preferences into “social” preferences. Unfortunately, even professional economists often engage in just this type of reasoning. Many people (try to) justify progressive income taxation, for example, by claiming that “a dollar means more to a poor man than to a rich man.” The idea is that taking $1 million from Bill Gates won’t lower his utility very much, whereas handing out $1,000 to a thousand different homeless people will greatly boost each of their utilities. Therefore, the typical argument goes, total or “social” utility has been increased by the redistribution of some of Bill Gates’s wealth.
In Lesson 18 we will examine the consequences of progressive income taxation. For now, we point out that the typical justification for it is absurd. You can’t add up different amounts of utility from various people. In fact, if you use the alternate term preferences it will be more apparent why combining them from different people is an impossible task. It makes sense to ask, “What is the total weight of the population?” or “What is the average age of the population?” It does not make sense to ask, “What is the total preferences of the population?” or “What is the average amount of utility per person?”
To make sure you understand just how nonsensical it is to (attempt to) perform arithmetical operations on different people’s preference rankings, once again let’s switch to the analogy of friendship. Suppose that Sally and Larry have the following “friendship rankings”:
Friendship Rankings

Before continuing, make sure you understand the table: Sally has five friends total. Her best friend is Bill, her second-best friend is Mary, and so on. Larry, on the other hand, only has two friends. His best friend is Joe, and Bill is his second-best friend. Notice that even among their shared friends, Sally and Larry don’t have the same ranking order. Sally thinks Bill is a better friend than Joe, while Larry thinks that Joe is a better friend than Bill. There is nothing strange about this, because preferences are subjective.4
Now suppose a busybody school administrator comes along and says, “This is terrible! Poor Larry doesn’t have as many friends as popular Sally! I have a great idea to make things fairer. I’ll write a note in Sally’s handwriting that says, ‘You smell!’ and put it in Adrian’s lunch bag. This will cause a big fight between Adrian and Sally, so he won’t be her friend anymore. Then I’ll arrange it so that Adrian sits near Larry on the school bus. They will eventually become friends. I can’t predict whether Adrian will become Larry’s 1st, 2nd, or 3rd-best friend, but no matter what, he will be ranked higher as a friend of Larry than he was as a friend of Sally. Through my benevolent intervention, I will have increased the total amount of friendship among the children.”
Obviously the above story is quite silly. But we have used a silly story to demonstrate the silliness of trying to add up subjective, individual preferences. Hopefully you can now see that trying to increase “social utility” by taking money from a rich man and giving it to a poor man, is simply nonsensical. Perhaps proponents of progressive taxation can justify it on other grounds, but appealing to the economic concept of preferences (or utility) doesn’t get the job done.

Lesson Recap...
Once we decide to classify certain events as purposeful actions, we can make further logical deductions. For example, for every action there must be an actor, an intelligent person who performed the action. Although people can act in combination with each other, any particular action is performed only by one person.
We interpret someone’s action by saying he or she has preferences. These are the goals that a person tries to achieve through actions.
Economists say that preferences are subjective, meaning that they are unique to each person. To call preferences subjective doesn’t condone or applaud them, it simply recognizes that people have different tastes.

Preferences: An individual’s goals or desires. Economists interpret a person’s actions as attempts to satisfy his or her preferences.
Goods: Scarce physical items that an individual values because they can help to satisfy his preferences.
Service: A person’s performance of a task that another person values because it helps to satisfy preferences. Services are the “goods” that people create through their labor power.
Subjective: Unique to each individual; “in the eye of the beholder.”
Utility: A term common in economics textbooks to describe how much value a person gets from a good or service.
Progressive income taxation: A system that taxes individuals or corporations at higher rates based on the level of income

Why is it questionable to say, “Germany attacked France”?
Why do statements about a man’s actions (implicitly) involve his beliefs as well?
Can purposeful action be based on a faulty belief? Give examples.
What does it mean when economists say preferences are subjective?
Does economics say you shouldn’t give money to charity?

Lessons for the Young Economist

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