Tuesday, January 22, 2019

Problems With Bryan Caplan's "Why I'm Not an Austrian Economist": Caplan Supports Laughable Indifference Curve Theory (Part 3)

By Robert Wenzel

Part 3 of my continuing series on Bryan Caplan's essay "Why I'm not an Austrian Economist." will examine the so-called indifference curve.

Remarkably, Caplan attacks Murray Rothbard for rejecting indifference theory:

 The utility function approach has a final implication that Rothbard rejected. Recall that using standard neoclassical definitions, U(a)>U(b) simply means that given the choice of a and b, a will be chosen, while U(a)<U(b) means that b would be selected. But what if U(a)=U(b); i.e., what if an agent is indifferent between two alternatives? Rothbard elaborated upon Mises by rejecting the very possibility as incoherent - and by implication rejecting the very use of indifference curves, a key building block of modern neoclassical theory.
Rothbard was correct in rejecting the indifference curve when he wrote:
The tendency to treat problems of human action in terms of equality of utility and of infinitely small steps is also apparent in recent writings on “indifference maps.” Almost the entire edifice of contemporary mathematical economics in consumption theory has been built on the “indifference” assumption. Its basis is the treatment of large-sized classes of combinations of two goods, between which the individual is indifferent in his valuations. Furthermore, the differences between them are infinitely small, so that smooth lines and tangents can be drawn. The crucial fallacy is that “indifference” cannot be a basis for action. If a man were really indifferent between two alternatives, he could not make any choice between them, and therefore the choice could not be revealed in action. We are interested in analyzing human action. Any action demonstrates choice based on preference: preference for one alternative over others. There is therefore no role for the concept of indifference in economics or in any other praxeological science. If it is a matter of indifference for a man whether he uses 5.1 or 5.2 ounces of butter for example, because the unit is too small for him to take into consideration, then there will be no occasion for him to act on this alternative. He will use butter in ounce units, instead of tenths of an ounce. For the same reason, there are no infinitely small steps in human action. Steps are only those that are significant to human beings; hence, they will always be finite and discrete.
But I believe that there is an even simpler way to show the absurdity of indifference curve theory and that it hardly ever exists and it tells us nothing. 

Let us take the discussion of indifference curves that is included in Harvard Professor Greg Mankiw's Principles of Economics (one of the most popular introductory economic textbooks of all-time).

Mankiw explains:
The consumer's preferences allow him to choose among different bundles of pizza and Pepsi. If you offer the consumer two different bundles, he chooses the bundles that suits his taste. If the two bundles suit his taste equally well we say the consumer is indifferent between the two bundles. 
Just as we have represented the consumer's budget constraint graphically, we can also represent his preferences graphically. We do this with indifference curves. An indifference curve shows the bundles of consumption to make the consumer equally happy. In this case, the indifference curve shows the combinations of pizza and Pepsi with which the consumer is equally satisfied.
Figure 2 shows two of the consumer's many indifference curves. The consumer is in different combinations of A, B, and C because they are all on the same curve. Not surprisingly, if the consumers consumption of pizza is reduced say from point A to point B, consumption of Pepsi must increase to keep him equally happy. If consumption of pizza is reduced again, from point B to point C the amount of Pepsi consumed must increase yet again.
This is Figure 2 which is on the same page as the text above and referenced by Mankiw:

Now, how idiotic can you get?

This theory is a serious case of the Emperor has no clothes. Compared to this, Keynesian nonsense looks like pure genius.

Let's take a real life look at Mankiw's example.

Suppose that after a long night out on the town, I stop into a local pizza shop for a Pepsi and a slice of pizza. I place my order. It's a special, a slice and Pepsi fountain drink for $5.00.

But they are out of pizza, so the clerk, who is a student at Harvard and who just took Mankiw's intro class,  looks at me and says, "I'm sorry, we are out of pizza. How many Pepsis would you like instead?"

I say, "What?"

He says, "Where are you on the indifference curve between pizzas and Pepsis. We are out of pizzas, so how many Pepsi fountain drinks do you want to substitute for the pizza, three, four, what?"

My choice: I walk out.

Another example, a woman walks into the office where her medical group operates, for her annual female checkup which includes a breast scan and a gynecological exam. And we run into another Mankiw student at the front desk.

She says to the woman, "I'm sorry. Our breast scan machine is down. How many gynecological exams would you like today instead, two, three?"

The woman says, "What?"

The Harvard student says, "What is your indifference between gynecological exams and breast scans?"

She walks out on this Mankiw nutjob.

The fact is that most bundles exist, at any specific time, in isolation, where no substitutes between two goods make any sense. For the most part, there are no indifference curves.

It is an extremely isolated occurrence (which Rothbard recognizes, see his discussion of Buridan's ass). Say, someone owes me $100 and he has two stacks of bills equal to one hundred dollars in front of him and that each stack contains a different mix of twenty dollar and ten dollar bills equal to $100. He may say "Which do you want?" At that point, I may be truly indifferent as to which one I get as long as I get one. But this is not a foundation upon which to build economic theory, when most of reality is not about indifference.

So now we have Caplan throwing Rothbard and Austrian economics under the bus because of their rejection of indifference theory that doesn't exist in most situations even if we ignore Rothbard's correct technical objection. How absurd.

Part 4 on Thursday.

The full "Problems With Bryan Caplan's 'Why I'm Not an Austrian Economist'" series is here.

Robert Wenzel is Editor & Publisher of

1 comment:

  1. This is such great stuff. Can you make these types of demolition jobs a regular occurrence?