Wednesday, January 12, 2011

Marginal Utility

Matt Yglesias points to an interesting hypothetical offered by Kevin Drum:
Suppose that you lead a comfortable middle-class life. Let's say that you're in your 30s, married, two children, and you make $100,000 per year. I offer you a fair coin flip with the following possible outcomes:

* Heads: You will be stripped of most of your assets and will earn $30,000 per year for the rest of your life. That's all you get, and neither friends nor family can top it up for you.
* Tails: You will earn $1 million per year for the rest of your life.

Would you take me up on my offer to flip the coin?

Long story short, most people would stick with the $100k and not flip. Drum explains it thusly:
We intuit, correctly I think, that life at the bottom of the working class is pretty damn tough, while life at the tippy top is more exciting, but perhaps not fundamentally different from life in the upper middle class.

Matt then uses this to emphasize a point he's been making for a while now -- the law of decreasing marginal utility applies to consumption. If true, then this means:
a dollar is a dollar the marginal utility associated with an additional dollar of consumption declines pretty sharply. This matters for politics in two important ways. One is that tippy-top inequality—the tendency of the top 0.01 percent to pull away from the rest of the 98th percentile—is perhaps important in political economy terms, but perhaps not so significant in terms of overall human welfare. The other point is that redistribution of consumption opportunities from the rich to the poor is an extremely effective means of enhancing overall human welfare.

What progressives like Matt and Kevin miss here is the assumptions they're making.

Two stick out. First, it's a static analysis. You're increasing welfare at that moment, it doesn't speak to maximizing overall welfare in the long run. Redistribution policies that maximize welfare at time t=0, might very well reduce future values of welfare.

To be honest, they're are only two things you can do with a dollar. You can spend it (.i.e. consume) or you can save it (.i.e. consume in the future.) By focusing on the utility of consumption, they are almost by definition focusing on the short-term.

Second, they that everybody is concerned or should be concerned about consumption, when FLG would argue that many of the wealthiest people are people who founded and grew companies. For example, somebody like Bill Gates isn't so concerned about the next dollar insofar as consumption is concerned, but to maintain control of his company he had to keep a certain percentage of his company's stock, which in turn grew. In this case, FLG would argue the diminishing utility of consumption doesn't matter.

Now, in fairness, capital gains taxes, such as Gates would face, aren't applicable until the gains are realized. And this wouldn't apply to the bete noire of the progressives -- greedy bankers.

1 comment:

Anonymous said...

What progressives like Matt and Kevin miss here is that a lot of folks (100s of 1000s if not millions)in their 40's and 50's who were living a comfortable life with their 2 kids have been stripped of their assets. While they may not be making 30 grand a year right now - they have little chance of earning what they used to. And about a zero chance of ever getting a million a year.

That's what the November election results were all about.

Mrs. P

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