Introduction to Economic Reasoning - Chapter 3: Action and Preference Part II

Given a value scale, an actor will choose his most highly preferred goal. How do we know this? It follows from the action axiom. Given a choice, a person will would rather choose the goal they prefer the most.

Some object to the idea that we always choose our highest preference. They say that that people choose less preferred over more highly preferred goals all the time. For example, a student who will be rewarded for getting an ‘A’ does not cheat if given the chance. This proves highly preferred goals are not necessarily chosen. In fact, however, this action actually shows that the student prefers not cheating more than getting an ‘A’.

Still others then criticize the above response. That “one’s highest preference is what one chooses” is tautological and therefore trivial. We learn nothing from this statement as the terms ‘choose’ and ‘preference’ are synonyms for one another.

In response Gordon clarifies the definition not as ‘one prefers what one has chosen’, but ‘one chooses what one most highly prefers’. He also notes that just because a statement is tautological does not make it trivial.

In fact, the notion of preference leads to the deduction of one the most important theories of economics, the theory of marginal utility.

Gordon illustrates the theory using an example. Imagine you have five preferences for using an orange. You happen to have one orange. Which preference will you use the orange to fulfill? Common sense dictates you will use the orange to fulfill your most highly valued preference. If you have two oranges, you will use them to fulfill your highest preference and next highest preference. An important implication is uncovered, however, if one starts with five oranges. Should you lose your third orange, will you forgo fulfilling your third highest preference? No, you will use your last orange to fulfill that preference. The implication arrives; one uses the last available unit (marginal unit) of a good to fulfill one’s least highly valued preference.

Some challenge the theory of marginal utility saying that it cannot help us in understanding cases of indifference. For example, what happens if I value the second and third preferences for orange use exactly the same. What will I do with the second orange? Burdian, a scholastic, famously illustrated the supposed implication of ranking preferences without considering indifference. He imagined a donkey that starves to death because it cannot decide which of two identical bales of hay to eat first. Rothbard, however, criticized this example. It implies that only two preferences exist (to eat the first bale of hay, to eat the second bale of hay) when actually there are three (eat the first, eat the second, starve to death). There is no indifference when it comes to eating a bale of hay in this case.

Indifference is not important in economics because it cannot be demonstrated in action. Economics is not concerned with how one might chooses between preferences one is indifferent about. Furthermore, the strength of one preference versus another is not important, only their ranking.

Gordon returns to Burdian’s Ass. He addresses the objection that it doesn’t matter whether the donkey wishes to avoid starving to death. The donkey must choose between two identical bales of hay and if a perfectly rational agent cannot do so. Gordon answers such a notion of perfect rationality is problematic. If perfectly rational, why should the donkey waste time reasoning as to how to choose a hay bale in order to avoid starvation?

Returning to the theory of marginal utility, Gordon seeks to address a frequent misconception. Restating the theory, as more units of good are acquired, an actor will apply each additional unit to the satisfaction of a subsequently less highly valued preference. Some economists (Gossen) seek to explain this process as the ‘satiation of wants.’ The ‘satiation of wants’ is a psychological theory may or may not be true, but it has no bearing on the science of economics. It is not deduced from action nor is it an axiomatic principle. Marginal utility says only that people apply units of a good to their most highly valued preference first, and so on down their preference scale. It is deduced solely form the action axiom and is not an attempt to explain why actors act in this way.

Gordon further claims that refuting the notion of choosing the most highly ranked preference based on psychological theory is unfounded. For example, an established psychological principle that a second bite of ice cream may be more pleasurable than the principle that an actor chooses their highest preference. Even if the psychological theory were true, this principle of action still stands. Preference scales need not consist of the single use of a good. Each preference could involve more than one good put to more than one use as well as different uses for different goods. Thus, two ice cream bites can be a single preference leaving the preference principle in tact.

The use actor’s see for goods, then, determines how goods are comprised in value scales. The uses actor’s see for goods is subjective. This does not mean the goods themselves are subjective as some ‘radical subjectivists’ claim. Goods have objective qualitative and quantitative attributes unlike the uses to which actors dedicate them.

In the real world an actor can satisfy their many different preferences with many different goods. Marginal utility recognizes this. Actors rank many different goods based on their assessment of how well these goods satisfy their many different preferences. As an actor acquires more goods, he will dedicate them to satisfy progressively less valued preferences.

Marginal utility applies not only to single actors, but also to actors involved in exchange. Exchanges can be either voluntary or involuntary (involving force or fraud). Economics mainly concerns the former.

Actors voluntarily exchange goods because each expects to benefit. They value the goods they exchange in reverse order. This valuation is the basis for prices.