So, what’s utility?

Emma writes*

The goal of economics is to improve the living conditions of people (Mankiw 2019). Hence, economics should focus on increasing human prosperity rather than just increasing material consumption. Of course, material wealth strongly correlates with well-being, as material wealth provides a sense of security, a roof over one’s head, food, and clothing. Yet, empirical evidence shows that this is only necessarily true up to a certain income. In the US, average income almost quadrupled while average happiness decreased That material wealth is not the only factor determining a good life is somewhat common sense. In basic psychology terms, what neoclassical economics concerns with are the “basic needs” in Maslow’s Pyramid of Needs:

Mainstream, neoclassical economics defines utility-maximization – utility being the satisfaction gained from consumption of goods and services – as the ultimate goal of every human. It is true that this is a necessary simplification for economic modelling, as material goods are tangible opposed to utility gained from action fulfilling “psychological needs”. Thus, this is a perfectly fine assumption to hold in the spheres of economics that do not directly require a prior stance on normative beliefs (like, for example, the belief that economic inequality is meritocratically justified because we live in a society with equal access to opportunities), say accounting of econometrics.

The problem is not the use of this assumption ipso facto but that this definition of utility as being formative for human happiness shapes economics and thus permeates into economic policy and shapes everyday economic interaction, set of beliefs, and society. Economics influences not only our access to basic needs but our psychological needs profoundly. It is fundamentally tied to the other social sciences in understanding and providing human prosperity. This is also why – how neoclassical economics proponents may argue – the statement that “psychological needs” are not directly the responsibility of economists, is, frankly, wrong.

To equate utility with material goods worked great in times of material scarcity; as for example after the two World Wars or in developing countries. Yet, in times of material over-abundance in developed countries, an economy governed by this principle may erode the fundamentals necessary for our psychological needs whilst over-providing materials for basic needs. As a great – neoclassical! – economist pointed out, “the art in economics lies in judging when a simplifying assumption clarifies our thinking and when it misleads us.” (Mankiw 2019). The neoclassical definition of utility is a necessary simplification and not a doctrine or even the attempt to fully reflect the nature of humans – but when this assumption may erode, in the very long-run, psychological needs whilst leading to an oversupply for basic needs, this assumption is misleading.
To put it simply, especially in developed countries with a robust welfare state the fixation on material goods seems outdated. A paradigm shift in economics from the emphasis on material goods as utility towards an emphasis of material good and human well-being as utility is necessary. By starting at the root problem with changing the definition, policy change will follow – to something more adequate than GDP maximization and achieving full employment.

Bottom line: The assumption equating utility with human satisfaction and happiness whilst only counting consumption as utility oversimplifies what we mean by human happiness. A paradigm shift in economics from the emphasis on material goods towards an emphasis on human well-being is necessary.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

4 thoughts on “So, what’s utility?”

  1. Hey Emma!

    Super interesting and well-written post. Your message is clear: the seemingly inherent truth to any ‘utility-maximization’ assumption only holds up if the accuracy of any definition of utility is constantly assessed, assessed and assessed. As you convincingly point out: assessing utility with material goods as measure works (arguably) well in times/places of dire scarcity; however, in times/places of over-abundance this assumption is inaccurate for many and will, in turn, perhaps lead us to orientate ourselves towards the wrong objectives.

    I wanted to briefly discuss your comment on Maslow’s Pyramid of Needs. You mention that neoclassical economics concerns itself with the ‘basic needs’ (referring to physiological and safety needs). I would like to ask you: to what extent do you think this is exclusive? Or, in other words, do you think this is a definitive statement or are there parts of neoclassical economics that do concern psychological and self-fulfilment needs (maybe through utility functions differing between individuals)?

    1. Hey Pieter! I really liked your summary, I have had difficulties putting my thoughts into words in a decisive and precise manner.

      I do not think it is exclusive. Admittedly, the distinction I made is a bit black-and-white. But I wanted to illustrate the trajectory of societies in developed countries with our outdated utility-assessment. And I wanted to contrast that this is actually so common-sense and general knowledge, yet ignored in, say, economic policy.

      On another note, I initially planned on talking about the role of wealth and income in self-actualization needs as well: Wealth buys opportunities and leisure time as well. I have been talking to people from people who make a living with art, the classic 9-5, and rich business people lately about whether they wanted to reduce their workload. Surprisingly to me, the answer often was no. Either because competition was too high, if you were to work less you would be out of the game (eg my mother who works as a costume designer, but therefore she self-actualizes (excuse my English) in her work), classic 9-5 with above-average earning, because that person wanted to buy him other opportunities that give him the opportunity for self-actualization ( into sports so his new pair of skis, his dive trip) instead for giving up 10 more hours every week. In summary, the crux is, wealth can buy you the tip of the pyramid. But that’s actually another topic. 🙂

  2. Hey Emma, great blogpost. Indeed, from our studies it seems like this argument is known and gaining power especially in the department of behavioural economics. Furthermore, I think instinctively, the non-economist individual views utility exactly the way you describe it, as in a way the definition of wellbeing. I don’t know if you’ll talk about it in your paper, but I wander when this dichotomy started and how – as economists are humans – it nearly seems absurd that there is such a contradiction between what individuals view as prosperity and what economists see as prosperity. Understanding why and how it happen may shed light on why this discipline does is still so rigid and not embracing of this concept. Finally, I have question, who do you think will be the force of changing this conceptual paradigm? Especially with the discussion on increasing inequality there’s a serious clash between what people want from the economy and what they get – partially due to this neo-classical agenda. Will pushing for a change in macroeconomic priorities come from the new economists, or the people?

    1. oh I’d love to know where this odd contradiction started, and under which circumstances – maybe with the start of econometrics? maybe with marginalism? A quick google (scholar) search did not reveal anything substantial. Maybe David has some more insight on this?:)

      To your question: I really don’t know, no one will know. I guess, as usual, both sides. More progressive economic strands permeate into the economic elite (think of who got the Nobel prize in the last 20,30 years), economics teaching will change. This is a promising start!

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