Academic journal article Journal of Economics and Economic Education Research

The Thrill of Simplicity, the Agony of Realism: An Assessment of the Sport of Utility Theory

Academic journal article Journal of Economics and Economic Education Research

The Thrill of Simplicity, the Agony of Realism: An Assessment of the Sport of Utility Theory

Article excerpt

INTRODUCTION

A framework for analysis of the choices made by individuals is a necessity for theorists who wish to understand a population of individuals and their behavior. The way to form an effective framework is to specify a model of reality based on a set of axioms that govern the population's behavior. The postulates that form the foundation for utility theory precisely characterize a simple form of 'rational' behavior. This set of conditions forms the analytical framework with which general statements can be formulated explaining choices ultimately made in the marketplace.

In an ongoing effort to better describe the choices made in various areas of economic activity, new assertions regarding, specifically, the over-simplicity of the basic theory of utility, and generally, of maximizing behavior, have appeared in much the same way that Keynes' revolutionary macroeconomic challenge occurred in the 1930's. In essence, Keynes observed that many real-world choices were made which were logical in their construction or apparent from observation, yet did not adhere to the axioms of classical microfoundational theory. As Keynes indicated, this can occur for a variety of reasons, some of which he identified and explored in developing his own macroeconomic General Theory (Keynes, 1964). In microeconomic theory, similar observations have been made for explaining behavior that appears rational, but seems unable to adhere to the axioms and properties of classical utility theory.

Often, an economist will assert that if a theory consistently explains or predicts well, there must be some kind of axiomatic foundation which governs the consistent behavior. The purpose for economists, therefore, should be to discover these governing axioms. Economists pursuing this purpose are counting on the premise that the factors affecting behavior have not yet been discovered. Those still pursuing that purpose after an initial theory is in place are counting on the premise that that the axioms have been analyzed incorrectly, that they are misstated, or that they are just plain wrong.

More recent work in microeconomics has revealed the position of classical utility theory as a rather extreme special case of a phenomenon found by many arguments to have much more complexity than the simple classical version. The purpose of this paper is to describe the current classroom presentation of the theory, present some of the efforts attempted to enhance the model, and to evaluate this effort in terms of generality, manageability, and congruence with reality.

THE BASIC UTILITY MODEL: THE THRILL OF SIMPLICITY

In its most basic form, utility theory serves as a means of ranking an individual's preferences by the level of appeal of available alternatives at a point in time. It also determines, among other things, the solution of variables endogenous to the model, such as the quantities of alternative products an individual will consume while maximizing utility under the restriction of a budget constraint. The rankings are based on axioms that describe 'economic rationality':

1. Completeness: If A and B are any two situations, then only one of the following can be true:

1) A is preferable to B

2) B is preferable to A

3) An individual is indifferent between A and B (Indecision is not an option)

2. Transitivity: If A is preferred to B, and B is preferred to C, then A must be preferred to C. An individual is assumed to fully understand the consequences of the choices to be made, and thus makes decisions that are internally consistent.

3. Continuity: If A is preferable to B, then outcomes "suitably close" to A are preferable to B also. This axiom is necessary in order to analyze differential changes in income and prices which affect outcomes to a small degree but are not sufficiently large to affect the ordinal ranking of situations (compiled from: Copeland, Weston 1988, Kreps, 1990, Nicholson, 1989, Chiang 1984). …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.