How much is 5 bucks worth?
I'm writing my term paper for cost-benefit on the change of the marginal utility of income with respect to income.
This issue is vigorously debated in economics, and it turns out, most of these debates are above my head and involve fairly impenetrable jargon and differential math that, I think, probably isn't that hard if I just had somebody to walk me through it, but that is pretty difficult to wade through in an article. But, I think I can elucidate some issues from a philosophical perspective.
Here's the basic question: Is 5 bucks worth the same amount to a rich person as it's worth for a poor person?
The person who says "yes, they're the same" would basically argue that 5 bucks is worth 5 bucks. In Cost-Benefit Analysis, the standard way to measure how much somebody values something is to examine how much they are willing to pay for it. But, when it comes to money, people will pay the face value of the money. How much would the poor person or the rich person be willing to pay for 5 bucks? The answer, obviously, is 5 bucks.
The person who says "no, they're not worth the same" would argue that money exhibits the same property of decreasing marginal utility that all goods exhibit. For any particular good in a given period of time, with each successive unit of consumption, a consumer receives a succesively lower amount of "utility" for the good. The fact that goods exhibit this property is not controversial. Money, the "no camp" would argue, exhibits the same property. The marginal utility of 5 bucks is higher for the poor person than the rich person.
This turns out to be both a complicated and an important question. It's important, because if it's true that marginal utility of income decreases as income increases, then income transfers from the rich to the poor will increase the total utility in the economy. In fact, ignoring the costs of disincentives and administration, it would argue for a complete equalization of incomes from a cost-benefit perspective. In practical terms, when performing Cost-benefit analyses on projects, it would "weight" costs and benefits to the poor more than costs and benefits to the rich.
If it isn't true, then costs and benefits would be weighted equally across all income groups. So, if a project yields a benefit to Mr. Moneybags of 10 bucks at the cost of 2 bucks each from Johnny Homeless, Cancer Annie, and Straightjacket Tom, then the project would still go forward.
Briefly, one of the main difficulties rests with the fact that we cannot measure utility (to simplify, utility is basically synonymous with happiness). We don't even really know what happiness is. There's a whole field of psychology devoted to the study of it. I think it's interesting that economics, which tries to pretend that it's not a social science at all but rather a system of a priori mathematical equations, here has to rely on the pseudo-science of psychology to explore this important issue.
Obviously, it's possible that two people can simply have different personalities. What if the poor person has an extremely flat affect whose maximum level of happiness NO MATTER WHAT HAPPENS is a 5 on a scale of 1 to 10, and the rich person has an extremely happy affect, with a maximum happiness of 10 and an average of 8. Maybe, then, the 5 bucks would mean more for the rich man than the poor man.
Another way of asking the question is to ask whether or not people approach some level of satiation of desires as their incomes increase. Is there simply nothing that the rich person could buy for 5 bucks that would yield utility? Or, is there an infinite number of things that the rich person would want to buy for 5 bucks? Is the human desire for stupid crap simply infinite? Obviously, the poor person's has less, and it may be reasonable to assume that he therefore wants more things, and it may be reasonable to assume therefore that the likelihood of finding a good that increases utility significantly is higher for the poor person. But, then again, maybe it isn't.
Well, if I spend my time writing on this blog, I won't write the real paper.
posted by Joe @ 6:57 PM
5 Comments:
I wasn’t aware that the marginal utility of income was really a subject of debate. It is the economic basis for progressive taxation and Thurston Howell III’s hilarious antics.
The reason why all income isn’t evenly distributed to that optimal utility/happiness point (n) where marginal returns begin is that wealth is ephemeral; existing in all 4 dimensions. Imagine it was possible to put a process in place where every day every dollar of wealth anyone accumulated over n – lets call it w -- was scraped off and redistributed to everyone with wealth below n. On day 1 utility/happiness would be maximized for the population. However on day 2 some of the smarter rich people would figure out that it’s stupid to have a level of productivity that could result in having wealth above n (as rich people are only motivated by self interest, as everyone knows) reducing the value of w. Conversely some of the smarter poor people figure out it’s stupid to attempt to increase productivity to n because they’ll just get a subsidy that will bring them up to n anyways. Each day the delta between the wealth of the poor and n would get bigger and the wealth of the rich and n would get smaller until all market participants would be =< n.
As long as wealth is linked to productivity redistribution will only destroy wealth; destroying utility.
I thought you might jump in on this one!
You're right that redistribution creates disincentives and creates transaction costs. That's why I mentioned "ignoring transaction costs" in my discussion. But, now, adding those, and ignoring ethical issues, the optimal level of taxation would be the point at which the utility gain from redistribution would be equal to the utility costs of redistribution. You're right that this point would be reached well before income was equalized. How to determine that optimal point is a task for people who are much, much better at math than I am.
Nevertheless, it doesn't change the fact that, in project appraisals of the cost-benefit variety, one tracks the benefits and costs to various stakeholders, whether it's a road project, a job training program, or anything else. Analysts need to know whether they should treat costs and benefits the same for all income groups, or whether they should weight them.
To be clear, marginal utility is not the only reason one might weight costs and benefits. That discussion is "positive" in that it's trying to measure true utility. One could also make an ethical argument that tries to put a "shadow price" on the value of improved equality. That's a completely seperate discussion.
I think we’re totally on the same page in regards to the optimal level of taxation AND project expenditure being where costs and benefits balance. Personally I’ve never found the arguments in support of flat tax plans particularly persuasive and see the value of progressive taxation where the burden of government is spread in proportion to the individual’s ability to bear it.
The only point where we might differ is the idea that income equality and maximum utility (as defined above) are in any way correlated. I’m firmly in the camp that believes inequality is necessary to provide incentive for innovation, which leads to greater productivity which leads to a greater standard of living (utility) for all.
BOOBIES!
I'll second that!
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