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Twenty Questions on Mises, Part I

In economics I am almost completely an autodidact. I also know that autodidacts can sometimes be a crankish, blinkered, downright ornery lot.

It is therefore in a spirit of humility that I am reading Ludwig von Mises' The Theory of Money and Credit. Boldly -- or modestly, I can't decide which -- I plan to ask a series of questions as I go; perhaps some economists out there can enlighten me by answering them. I foresee this as a major blogging project, something that will go on for several weeks as I wend my way through Mises' dense, abstract, idea-rich prose.

I expect that most of the posts in this projected series will be short, simple, and hopefully helpful to other nonspecialists. To the best of my ability, I will include a synopsis of what Mises meant so that even those who have not read the text will be able to understand my questions and hopefully discuss them with me. (I understand, of course, that many of the questions will be the products of my own misunderstanding. I ask that you be kind to me when they are.)

Obviously, I intend the comments to be the most interesting part of the process. All posts in the series will be crossposted at Positive Liberty, but I will repost the most interesting and/or helpful comments at Liberty & Power as well. By commenting, you consent to letting me borrow your words in this way; I will keep attributions and links to the originals.

Archetypically, I'm aiming for twenty questions in twenty posts. The first is below the fold.

In the foreword, Murray Rothbard writes,

[N]eglect of the Cuhel-Mises theory of ordinal marginal utility allowed Western economists, led by Hicks and Allen in the mid-1930s, to throw out marginal utility altogether in favor of the fallacious "indifference curve" approach, now familiar in micro textbooks.

Rothbard, of course, did not use links to Wikipedia. But you get the idea. Here's my question: Why is the indifference curve "fallacious" in light of ordinal marginal utility?

Here is what I presume is a good concise definition of marginal utility, by way of Wikipedia. It seems consonant with Mises' own views, expressed later in TM&C.

In economics, marginal utility is the least urgent use of an object in satisfying a want - in other words, the use that is in the "margin." Marginal utility is subjective, because it depends on each person's wants and tastes. The same object may have different marginal utilities for different people.

For example, let us assume that a person has three wants and the satisfaction of each want each requires one gallon of water, so that satisfying all his wants requires three gallons of water. In descending priority, the most urgent want is to satisfy his thirst, the second most want is to give water to his dog, and his least urgent want is to water his roses. The least urgent use (the marginal utility) of one gallon of water when he has two is therefore to give water to his dog. If he has three gallons of water, then the least urgent use would be to water his roses. The "marginal utility" of any given gallon of water depends on how much water he has.

The concept of marginal utility is said to explain the "diamond-water paradox" most usually associated with Adam Smith. Smith asked, if water is more useful than diamonds, then why does water have a lower market price than diamonds? Marginalists answer that it is not the total usefulness that matters, but the usefulness of each unit of water. It is true that the total utility of water to people is tremendous, because they need to survive. However, since water is in such large supply in the world, the marginal utility of water is low. In other words, each additional unit of water that becomes available can be applied to less urgent uses as more urgent uses for water are satisfied. Therefore, any particular unit of water becomes worth less to people as the supply of water increases.

Unless I miss some subtlety (the curse of the autodidact is always to miss some subtlety), this definition seems adequate. Marginal utility is said to be "ordinal" because, in the context of a given good, it concerns the satisfaction of our most pressing want, followed by our second most pressing want, followed by our third, and so forth. Yet it is not absolute, and it cannot, as Mises argued, be reduced to any abstract unit of satisfaction.

The reasons for this are twofold: We cannot speak of units of satisfaction because satisfaction of want, insofar as it inheres in obtaining a good, comes always in the context of marginal utility. Satisfaction is a moving target, and quantified units of satisfaction have no fixed point to base themselves upon. It's all marginal, and therefore every exchange takes place at a different level of relative satisfactions.

We also cannot speak of units of satisfaction because while our wants are ordinal, there is no psychological method (yet?) of quantifying the difference in satisfaction that one takes between giving water to a dog and giving water to roses. While we may prefer one to the other, any quantity attached to this preference must be the product of our imagination (an ordinal preference, though, is not imaginary, since we can generally order our wants through introspection, and these, by definition, are actually what we want).

Now, here's an explanation of the indifference curve, which I also recall from my microeconomics textbook:

An indifference curve is a graph showing combinations of goods for which a consumer is indifferent, that is, it has no preference for one combination versus another, as they render the same level of satisfaction (or the same amount of utility) for the consumer. Curves are a device to represent preferences and are used in choice theory...

There follows a good deal of mathematical discussion which does not transcribe well into WordPress.

To repeat the question: Why is the indifference curve fallacious? I cannot see, simply by introspection, why such a thing should be fallacious in itself. On the contrary, it seems obvious to me that it is real -- and obvious even to the point of triviality. Nor can I see how the indifference curve stands in conflict with the notion of ordinal marginal utility: It might well be that I do not care about the change in quantity along a curve. One Coke? One Pepsi? Personally, I do not care at all, I can't tell them apart, even on a good day -- so an indifference curve certainly exists here for me. What am I not getting?

One question down, probably about nineteen to go. Stay tuned.

Posted on Thursday, November 23, 2006 at 7:21 AM | Comments (21) | Return

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