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Picking up on a theme from two years ago, let’s consider again the argument in favor of progressive (re)distribution of income from the wealthiest to the poorest.  The argument I made back then was that on basic behavioral grounds, the assumption that taking a dollar from the rich and giving it to the poor would increase aggregate utility does not follow. And it does not follow precisely for the reasons behavioralists tell us. First, there is no reason to believe that another dollar to an already rich person provides less utility than a dollar to a poor person. There is no theory that can conclude that.  Second, and perhaps more important, is that loss aversion may reverse the results aimed for by the transfer of wealth. People suffer more utility loss from the loss of a dollar than they gain from the securing of a dollar.

Those objections have never been adequately dealt with. And to those I’d like to add two more.

  1. The idea that there is diminishing marginal utility in consumption is not exactly the same as whether there is diminishing marginal utility in the purchasing media. We may be getting a little ahead of ourselves here – but when we learn basic economics, we end up teaching something like the second slice of pizza gives us less satisfaction than the first, and the third in turn gives us less satisfaction than the second. This is most definitely not the same as saying that the third dollar gives us less satisfaction than the second which gives us less than the first.

    Now, if (and this is ironic, isn’t it) you want to assume that all markets are supremely perfectly competitive, that all economic agents are always optimizing with full information 100% of the time, and that they cannot adjust their consumption in any way to make themselves better off at the current income and price levels that prevail, then maybe the conflation of diminishing marginal utility of consumption and diminishing marginal utility of dollar bills would be acceptable. But critics tell us regularly (and I do not disagree) that the idea of perfectly competitive markets is a myth, and that it is not even remotely possible that we are optimizing all of the time.

    If we WERE optimizing all of the time, consumers would end up allocating their (marginal) dollars so that, at the margin, the very last dollar spent on every single item provided them with exactly the same amount of satisfaction.

    But if we are not going to be comfortable making that assumption, then it does not follow that the satisfaction provided by spending that last dollar on apples is the same as the satisfaction we would have gotten spending it on pears. In other words, since a dollar allows us to purchase ANYTHING on offer in the entire economy, if in fact there are diminishing marginal gains to additional dollars, they would have to set in at consumption levels far beyond anything any normal person could ever achieve. So, while, right at this moment, if you had me spend one additional dollar on coffee (I am on my third cup) it would not make me happy, that does not mean that taking a dollar from me would not diminish my happiness. That dollar enables me to buy a piece of a book, a few minutes of a phone call, some cleaner for my eyeglasses, and so on. Since resources are scarce, it is implausible that I have already reached a point of satiation in all of those things and more. And if the (re)distributionists are going to nonetheless argue that I get less satisfaction from reading the next book than someone else (who would be receiving my dollar) who would use that dollar to purchase bacon, they are going to be left with a morally bankrupt argument that boils down to, “we just know that person X likes bacon more than you like books.” There is no other foundational theory to rest such an assumption on aside from it just being an assumption, a preference, a non-universal value.

  2. The argument of the (re)distributionists is that global utility increases from redistribution. Take a dollar from Wintercow, his utility falls by less than the dollar being given to Summercow. QED. Not so fast. When you simply execute income transfers, remember that you are going to be doing nothing to the productive capacity of an economy (ignore Laffer-type effects). Poorer people will have more income and richer people will have less. The prices of things that the rich buy, due to lower demand, will fall a bit. At the same time, since we live in a world of scarcity, the prices of things the poor buy, due to higher demand, will rise a bit. So, while some of the losses to the rich will be dampened, the gains to the poor will be dampened. But what now happens to the people who are not poor, but close to it, but now face higher prices for the important things they need to buy? Will not their utility fall, and fall as much as the gains to the poor who have received the (re)distribution? You may also argue that the near rich see utility gains, and that those gains nearly offset the losses to the actual rich. By my mind, taking into account the equilibrium impacts on prices, there may be no net change in utility from the redistribution at all. In that case, the argument for redistribution cannot come on aggregate utilitarian grounds but must come from elsewhere.

Call me crazy for expecting these ideas to be dealt with.

One Response to “More on the Diminishing Marginal Utility of Wealth”

  1. Tom Bowler says:

    An interesting argument, but one that (by necessity maybe) ignores the true nature of redistribution. Dollars taken from the wealthiest go first to central pool of dollars controlled by the government, who as transfer agent takes its cut from the income stream. What is left of the dollars from the wealthiest form the purchasing power with which progressive politicians buy chances on future votes. The likelihood of the chance for a future vote becoming an actual vote is directly related to the negative impact on the voter if he is not able to exchange his potential future vote for cash.

    The argument against redistribution cannot come on aggregate utilitarian grounds, since they are totally irrelevant to transaction in which potential future votes are traded for cash. In the end I guess I’m agreeing with you. :)

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