Hayek and Indifference Curves

Economics Economics Questions
1

Here’s an interesting bit of intellectual history. In his interview with Alchian, Hayek claims that he pointed Hicks’ attn to indifference curves. If that is true, it would be pretty crazy because Hicks and Allen were the economists that really established that indifference curves as the basis for an ordinal analysis of consumer behavior.

Que: OMG but Hoppe says it ain’t ordinal! :stuck_out_tongue: Any way, I’m glad Hayek was “attracted” to indifference curve analysis and found it “most satisfactory”.

HAYEK: Oh, '31 or '32. I started teaching in London in the autumn of '31; I suppose it was in that year that we started on the theory of production. It turned on a paper model of the production function which somebody had made. And [Roy] Allen and Hicks were evolving their own theories.

ALCHIAN: This is R.G.D. Allen?

HAYEK: R.G.D. Allen and John Hicks were developing their own theories. I don’t think whether I ought to mention it–I doubt whether John Hicks remembers it–but it’s almost a joke of history that I had to draw Hicks’s attention, who came from [Alfred] Marshall, to indifference curves.

ALCHIAN: That was a well-planted seed, all right. How did you happen to know about indifference curves?

HAYEK: Oh, I had of course spent all my early years on utility analysis and all these forms, and we had in Vienna-- [Paul] Rosenstein-Rodan, who wrote that great article on marginal utility, and with him we waded through the whole literature on the subject of marginal utility, including-- I was very attracted, in a way, by the indifference-curve analysis. I thought it was really the most satisfactory form, particularly when it became clear that it unified the theory of production and the theory of utility with a similar apparatus.

http://hayek.ufm.edu/index.php?title=Armen_A._Alchian

2

Just a quick thought: I don’t see why this notion of indifference can’t be incorporated into Austrian-school economics as another imaginary construction (akin to that of the evenly rotating economy).

3

branding. :stuck_out_tongue:

4

By “branding”, do you mean the fact that this notion of indifference wasn’t developed by an Austrian-school economist?

5

I haven’t taken intermediate micro, which is where I understand most work with indifference curves takes place, I’ve never really seen the need for indifference curves. I don’t (currently) see utility theory as very important beyond some basic essential aspects, and I just feel that the Austrian “utility list” view makes so much more sense.

I also like Rothbard’s basic critique of indifference curves which was just that it very rarely actually applies, and it’s impossible to be purely indifferent because at some point you have to make an arbitrary decision and choose one or the other or else you’re making the worst choice of choosing neither. Nonetheless I see no basic problem with indifference curves, nor do I think they’re really wrong. Perhaps Hayek’s own words here are indicative of the fact that they are more useful than I currently feel.

6

This isn’t exactly news… I think I may have commented on it before and there is a literature on Hayek’s sympathies with Walrasianism and GE theory. Many in the Mises-Hayek dehomogenisation debate have emphasised this which is why Hayek did not share Mises’ strong conclusion that economic calculation is impossible in principle (since a social planner can solve Walras’ equations), but only in practice(as he claimed the information was too dispersed and never centralised).

To offer my own 2 cents, I don’t think the proper distinction between these 2 theoretical frameworks has ever been properly stated. First both approaches are ordinal (Bob Murphy is correct when making this point), but how they are ordinal differs importantly. The praxeological approach starts with ends/purposes ordinally ranked and derives from this when means-end relations are uniform among the ends achievable between means considered (e.g. the marginal and submarginal and supramarginal ends require the same number of means to be achieved, e.g. 1 egg can make an omlette or a boiled egg) the principle of diminishing marginal utillity where marginal utility is understood therefore as the value of any of n units of a means that is equivalent to the value ranking of the nth most valued end. Thus marginal utility is an ordinal concept this way. On the other hand the value of a totality of means does not enter the picture is no considered at this level, unless considered separately in which tradeoffs between these as marginal units is being considered (though I think Rothbard is dangerously flippant in dismissing scenarios with marginal units and totalities of means in MES). There is no equivalence of rankings taken (or required in this framework), so ordinally ranked ends are ranked 1st, 2nd… nth, etc. Also as Nozick seemd to take great pride in pointing out there is an indifference concept used in the Austrian definition of a good that is entirely subjective definied from the view of the actor and not technologically as units that are viewed as perfectly substitutable to achieving the actor’s ends in his circumstances.

OTOH, the neoclassical framework, while ordinal is so in an entirely different way. One takes “bundles”(totalities of possibly heterogeneous goods) as being ranked ordinally by an individual forming a set satisfying completeness and transitivity requirements in accord with a binary " weak preference relation" (usually), and explicitly can allow for equivalent ranking of bundles (not always employed, like for lexicographical preference sets nobody cares about) . When these along with other often auxiliary properties (such as convexity for dMRS) are satisfied, then these ordinal rankings along with equivalences can be represented by a cardinal utility function. So total utility of each bundle is an ordinal ranking in this framweork, while marginal utility becomes an unavoidably cardinal concept in this framework with dMU becoming a merely conventional assumption as opposed to a theorem derived from an understanding of ordinal ranking of ends implied and expressed by action. Furthermore, it becomes no longer a necessary part of this framework or a necessary assumption since only dMRS is required to obtain sensible results, and as Hicks admitted in 1939, is an entirely “rabbit out of the hat” assumption.

That being said I can understand the appeal of the neoclassical approach. one can very cleanly do some simple maths (or geometry) and get results that seem quite solid and intiutively satisfying and expressive of tradeoffs in a metaphorical way (coming from a mathematical background myself, I do confess I’ve sometimes have had heuristic frustrations with Austrian treatments though I agree with their principles. That being said I think there are some interesting results for commercial valuation that can be derived mathematically using the Austrian approach to the subject, though I shall save discussing that for another day). However, the assumptions usually employed along with it have no necessary truth (like globally convex and intransitive preferences over n dimensional goods spaces) though this is often assumed or glossed over. On the other hand, you can’t derive it from the same type of fundamental considerations of Action Menger/ Mises used to derive the Austrian version of dMU and thus solidly refute things like the Diamond-Water paradox.

@Neodoxy, I’m sorry I didn’t get back to you regarding your article. I’ve read through it. I’m off work for a few days and will try to send you my comments soon (unless you’ve already published).

7

The article has not been published. I’ve gotten really sidetracked with school and life and I’m also undergoing something of an ideological economic crises at the current time. Nonetheless I’d really appreciate your opinions, although be warned that there are several other parts to the article “series” I would like you to look over if you do have the time.

Thanks

8

This isn’t exactly news… I think I may have commented on it before and there is a literature on Hayek’s sympathies with Walrasianism and GE theory.

It’s a 30 year old interview. I never claimed it was “news”. I had just never heard the annecdote about Hayek introducing indifference curves to Hicks. If you’ve heard it before, well…

Furthermore, it becomes no longer a necessary part of this framework or a necessary assumption since only dMRS is required to obtain sensible results, and as Hicks admitted in 1939, is an entirely “rabbit out of the hat” assumption.

I’m not sure what you mean when you say Hicks “admitted” it was a rabbit out of the hat assumption. Do you mean he thought the assumption was arbitrary? That’s how it sounds. And it is certainly how wikipedia spins that one-line quote (not suprisingly in the “Austrian” portion of its article on Marginalism).

But it actually is not true. Hicks clearly states later in the same paragraph you are quoting that it is dMRS is a good starting assumption because it is the “simplest” at our disposal and “its accordance with experience seems definitely good”. I would have to agree.
https://webspace.utexas.edu/hcleaver/www/368/368hicksVCutility2.htm

As Hicks notes earlier in the chapter, if dMRS didn’t hold, you wind up with kinky indifference curves, which wouldn’t conform with our experience. Specifically, he says that “if there are kinks in the curves, curious consequences follow, such that there will be some systems of prices at which the consumer will be unable to choose between two different ways of spending his income.” So the dMRS assumption rules out theoretical oddities that we don’t really observe in the real world.

Hicks doesn’t mention this, but we could have continious indifference curves that exhibit increasing MRS through out. That is theoretically possible, but those also don’t conform with our real-world experience. Why? Because increasing MRS would imply corner solutions where consumers spend all their income on a single good. I don’t know of too many people who behave that way. So no matter how you slice it, dMRS is a pretty good starting point because it is simple and conforms to much of our experience of how humans behave, exactly as John Hicks says. There is nothing arbitrary about it.

On a less substanative note, I would be tempted to go further and say that you (and wikipedia) totally mischaracterize the metaphore Hicks is making. You said that Hicks called the assumption of dMRS a “rabbit out of a hat”. I disagree. If you read the 2 paragraphs surrounding the quote, you will see that he is saying it is the economic LAWS (like consumer responses to price changes i.e. the shape of demand curves) that can appear to be magic or “rabbits out of a hat”. But, he says, there really isn’t any magic about these laws. Economists put the rabbits into the hat through the assumptions they make (like dMRS).

At least, that is the way I read the passage. But I am not going to try and argue over the best way to interpret a 70 year old metaphor. I will just wanted to throw it out there that you may want to re-read that chapter. The more substanative point is that no matter what Wikipedia says, John Hicks didn’t think there was anything magical or arbitrary about the dMRS assumption.

9

I haven’t taken intermediate micro, which is where I understand most work with indifference curves takes place, I’ve never really seen the need for indifference curves. I don’t (currently) see utility theory as very important beyond some basic essential aspects, and I just feel that the Austrian “utility list” view makes so much more sense.

@NEO: Well, in undergrad econ, indifference curve analysis is basically just used to show why demand curves typically slope downward by graphically showing how utility is maximized subject to some fixed income and fixed prices. And in this context maybe the value scale approach is just as attractive because it will get you to the same answer. But the utility maxinimization framework is much more useful than that.

For example, try moving to a context where you don’t take income as fixed so that a person not only has to decide how much to consume but how much to work/produce. The problem is not that much harder in the context of utility maximization. The only thing that has changed is the constraint. In the value scale approach, it is apparently not so easy. You can see this by checking out a couple of articles from the early 2000s (i think from the QJAE) that were dealing with whether one can derive back-ward being labor supply curve! This is a theoretical point that was settled in mainstream econ decades ago. Yet it is apparently still up for debate in some Austrian circles.

And I don’t think I’ve even seen a Rothbardian economist try to model some aspects of the production-consumption decision. For example, say you produce bubble gum, which you sell to earn income and that you use the income to buy goods including bubble gum. If the price of bubble gum increases, do you chew more gum or less or the exact same ammount? What factors does the answer depend on? Good luck trying to answer this with value scales.

But don’t take my word for it. Google around. See how many papers you can find where the author uses value scales for something other than just illustrating the shape of a demand curve for a normal good. :stuck_out_tongue: For an approach that is clearly better than utility maximization it doesn’t get very much use.

Of course, I don’t want to hijack my own thread with a discussion about value scales, especially since I am no expert on them. I just wanted to suggest you give it time before you make up your mind. Value scales may seem a lot easier for simple questions. But there are many more interesting questions out there than just “how does quantity demanded changes with price”.

10

If the price of bubble gum increases, do you chew more gum or less or the exact same ammount? What factors does the answer depend on?

Are you making more money, or less, or the exact same amount?

If you are making more, you might eat more. If the same, but since gum has risen in price, then it’s more expensive for you to chew gum [both because of increased costs of production, probably, and certainly because you are eating into the profits more], so you’ll eat less. If you make the same or less, then of course you will eat less gum, too. You cannot afford to anymore.

All that is if we ignore value scales. If gum is at the very top of your scale, and life is not worth living without five packs a day, which is what you are chewing now, then no matter what happens, you will not chew less. If we think about heroin to a heroin dealing addict, this might be a real life situation. If the N+1st piece of gum is below some other want on the value scale, and a pair of shoes is more important than that extra piece of gum, then you will chew the same amount [not more] even if you are making more [if the extra money only allows for things higher on the scale than the N+1st piece of gum].

Of course, all this assumes that your scale of values has not changed. If the higher price means you are losing money, then you may be more stressed, and may need more gum chewing comfort, moving piece N+1 higher up the scale. If you are making more money, and now hang around with a more snooty crowd that disapproves of public gum chewing, then you will chew less. Even if you are making the same, and prices have not even changed, but you find your teeth rotting from all that gum chewing, you might chew less.

Nice to know indifference curves give all this info, and more. I never knew.

11

Yeah I was referring to “news” in the sense I think it’s been brought up here and elsewhere before, but no matter.

Fair point on Hicks, apologies for the overstatement. He is referring more generally to these types of starting assumptions(like dMU, dMRS) in that starting section as appearing like “rabbit out o the hat” assumptions. Yes the continuous dMRS/convexity means that you can get the utility hypersurface to make unique tangencies with a flat hypersurface and thus derive unique solutions to a constrained maximisation problem. I admit this has an intuitive “feel” to it, but it seems to be an assumption that may seem harmeless and intuitve considering tradeoffs between bundles of 2 goods at the 2 goods level where we can draw indifference curves but far more brave (along with transitivity), to hold across all tradeoffs globally for an N dimensional goods space of bundles (though it is necessary to yield tractable results). Furthermore, the lack of problems with kinks is only a byproduct of the fact that you are solving to find a consumer’s demand with prices “given” under “perfectly competitive” conditions for which dMRS yields problems in yielding solutions as soon as this flat hypersurface assumption is dropped. Now I admit this might be justified (as it usually is) in the sense that it is a good approximation(though there is experimental work that suggests the price taking assumption is innacurate even for large double auction and posted offer auction markets) and allows you to get your work done.

I guess what bothers me with this sort of thing is that the assumptions are not truly adopted because of allgedly making “intuitve” sense as is claimed in cases like the above, but rather that they help yield nice, determinate solutions to calculus based optimisation problems. Hence e.g. for the profit maximisation problem of a perfectly competitive firm though CRS is the only assumption that makes physical sense (in terms of thermodynamic laws), it is neatly dropped for DRS since you can then get unique tangencies with a flat isoprofit line/surface and a determinate solution.

Also, I do agree with you about that there is an embarassing lack of progress made by modern day “Austrians” in advancing the framework to deal with these basic types of questions that you allude to. Perhaps it could be because there were so few “Austrians” for a long time until quite recently (and the vast majority of modern day “Austrians” are laymen), or it could be as Klein has pointed out a socilogical problem that most self described “Austrains” have spent most of their time writing on quasi-philosphical issues or fashionable things like ABCT, as opposed to what he labels “Mundane Economics.” Or perhaps it could be that the “value scale” framework is unavoidably sterile :P. (which is difficult for me, since I’ve been too anal retentive about the way assumptions have been utilised in the neoclassical approach to have been satisfied with it either)

12

I haven’t taken intermediate micro

Waht???

13

I’ve been away for easter,but I am back with a few short comments.

First, I think Smiling Dave’s comment illustrates perfectly why I personally dislike value scales. So I’m going to quickly comment on it once. I say I am only going to comment on it once because I don’t want to derail my whole thread on to a discussion of value scales. If Smiling Dave feels the need to respond to me that’s fine, he can have the last word on the subject. But, better yet, he can write a humble blog post on the subject.

If you are making more, you might eat more…All that is if we ignore value scales. If gum is at the very top of your scale, and life is not worth living without five packs a day, which is what you are chewing now, then no matter what happens, you will not chew less. If we think about heroin to a heroin dealing addict, this might be a real life situation. If the N+1st piece of gum is below some other want on the value scale, and a pair of shoes is more important than that extra piece of gum, then you will chew the same amount [not more] even if you are making more [if the extra money only allows for things higher on the scale than the N+1st piece of gum].

In the relevant portions of Smiling Dave’s discussion, he talks about whether the increase in the price of gum will earn the gum maker more income and how he values the new items he can afford. In mainstream econ, we would call this the “income effect”.

Oddly, he NEVER mentions that how much gum the gum maker chews may be influenced by the PRICE OF GUM ITSELF. Specifically, because the price of gum has increased, the opportunity cost of chewing gum has also increased (you must give up more other goods for each stick of gum). This increased opportunity cost might lead you to chew less gum as you substitute away to other goods that are now relatively less expensive (a type of “substitution effect”). This seems like a pretty HUGE omission!

Does Smiling Dave really think that relative prices don’t matter for the gum maker’s decision? More than likely he does, but he just forgot to mention it.

This is one reason I dislike the value scale approach. It is easy to make these sorts of errors of omission because there is no easy way to keep track of all the moving parts (graphs and/or math are helpful in this regard).

Of course, maybe Smiling Dave really does think the relative price of gum is irrelevant here. And I really couldn’t argue. Why? Because, like I was saying in a previous thread, there is no uniform way to apply the value scale approach. Different people analyse the same problems with (supposedly) the same analytical tools and get different answers.
http://libertyhq.freeforums.org/neoclassical-theory-proves-giffen-goods-exist-t275.html

For example, if you ask Pascal Salin, he thinks income effects don’t exist at all and is inconsistant with Rothbard’s analysis.

If you ask Rodolfo Gonzalez, he think Salin is wrong and that income effects do exist:

If you think the value scale approach is an alternative to indifference curve analysis, this should really worry you.

Now, that’s all I have to say on the matter. Like I said, I’m not going to derail my own thread. Well..I’m not going to derail on this stuff anyways.

14

Now, on to more substantive matters. Absk, thanks for the thoughtful comment. I just have a few questins.

I guess what bothers me with this sort of thing is that the assumptions are not truly adopted because of allgedly making “intuitve” sense as is claimed in cases like the above, but rather that they help yield nice, determinate solutions to calculus based optimisation problems. Hence e.g. for the profit maximisation problem of a perfectly competitive firm though CRS is the only assumption that makes physical sense (in terms of thermodynamic laws), it is neatly dropped for DRS since you can then get unique tangencies with a flat isoprofit line/surface and a determinate solution.

Could you elaborate why you think CRS is the only assumption that makes sense? I mean, from a short-run perspective (where at least one input is fixed), I don’t see how you could avoid DRS in at least some circumstances.

But beyond that, econ grad students are forced to deal with production functions that display global DRS and CRS. I’ve never seen one dropped for the other. Check out Reny and Jehle’s Microeconomic Theory. You will find plenty of examples.

Perhaps it could be because there were so few “Austrians” for a long time until quite recently (and the vast majority of modern day “Austrians” are laymen), or it could be as Klein has pointed out a socilogical problem that most self described “Austrains” have spent most of their time writing on quasi-philosphical issues or fashionable things like ABCT, as opposed to what he labels "Mundane Economics.

Agreed.

Peter Leeson (my favorite breathing Austrian economist) also made this point a few years back. I think he had a list of 10 things Austrians should avoid. And I’m pretty sure one of them was “don’t write any more articles on methodology!!”

15

Well, in a rather fundamental sense, every act of (physical) production is one of transformation from one form of matter and energy to another, in which energy must balance on both sides and cannot be created or destroyed (interesting historical note: Sadi Carnot, the French Engineer who developed the initial formulation of what would become the first law of thermodnamics was inspired by an analogy from double account book keeping). Hence since ultimately what goes in production from both input and output have to balance in a physical sense, this also means that if we change the scale, the ratios of input to output should not change and should be scale invariant, else we would have a violation of the first law of thermodynamics. An example with a fixed factor would not be a violation of CRS or the first law, but an illustration rather of the Law of Returns, since you would not be changing scale as factor proportions would not be kept constant. In fact I think every supposed “observation” of DRS or IRS is from not properly taking into account implicit inputs that were not prior considered explicit controllable factors at the initial scale of production, but upon a change of scale, the limitations of which in relation to their changed proportion to every other input were revealed, thus making them just applications of the Law of Returns. Incidentally, Cobb Douglas production functions are another pet peeve of mine, given that they are supposed to be exemplary of illustrating the Law of Returns’ application, imply infinite marginal productivities as the differentiated (w.r.t) factor tends to zero! A physicallly nonsensical “production function” if there ever was one.

I may give Jehle and Reny a try some day, I’ve scanned through the early sections of the book before and got the feeling it would have been a lot more tolerable than Mas-Colell. In retrospect I should perhaps have used it last year than trying to digest Mas-Colell (an intolerably written book IMO), and in the end just using far more useful course notes.

On Pete Leeson. I read that blog post of his too. I sympathised with it a bit but I’m not sure if I’m fully in accord with his approach or that of others at GMU which also doesn’t seem to be trying to work out/elaborate the logic of the Austrian approach to price theory but rather to do mostly applied neoclassical economics with an Austrian “flavour”/emphasis(Not that that’s at all a bad thing). This was the article of Klein’s I was vaguely alluding to earlier in any case: http://mises.org/journals/qjae/pdf/qjae11_3_1.pdf

Interestingly that article reads a bit as an underhanded shot at some of the work by the GMU guys in the past 3 decades. I guess the implicit potshots go both ways. :stuck_out_tongue:

16

Oddly, he NEVER mentions that how much gum the gum maker chews may be influenced by the PRICE OF GUM ITSELF. Specifically, because the price of gum has increased, the opportunity cost of chewing gum has also increased (you must give up more other goods for each stick of gum).

True enough, didn’t think of that.

But Student has it all wrong about opportunity costs. Since there is the same, finite amount of money to be spent, the price of gum rising means the price of everything else has dropped. So the opportunity cost of gum has not increased necessarily. It may have even decreased.

I do wonder about the real world application of indifference curves. Can you show me a prediction that was made using indifference curves, and that came true? Link, of course.

Value scales are important. First, they are true. People actually do like one thing more than another. Second, they lead to important true theoretical insights of predictive value. Be nice to see if the same is true of indifference curves, or are they just useless and pointless knowledge?

17

@Wheylous

What?

18

Still waiting on an answer from you, Student.

19

By “branding”, do you mean the fact that this notion of indifference wasn’t developed by an Austrian-school economist?

By branding I meant that it is hard to bill yourself as a truly unique alternative to mainstream economics if you accept and use on of its most basic models.

20

Austrian-school economics uses the concept of marginal utility just like mainstream economics does - right?