LESSON 3 Economic Concepts Implied By Action

In this lesson you will learn:

• Why only individuals, not collectives, can make choices.
• How economists use preferences to explain individual choices.
• The proper way to think about preferences.

Introduction

In the previous lesson we stressed the distinction between purposeful action versus mindless behavior. Economics studies the former; everything in economics is ultimately connected to the fact that we, as outside analysts, are imputing conscious motives behind the events we are trying to describe. We can’t even classify a physical object as “money”—let alone give an explanation of its purchasing power—unless we “get inside the heads” of the people who are passing around various pieces of this object. (After all, people pass germs around too, but we don’t classify them as money!)

Economics is the methodical, or scientific, study of exchanges. An exchange—in the sense that we use it in this book—is very definitely a purposeful action. In this lesson, we are going to spin out some of the logical implications of our decision to study exchanges. To repeat the message from the previous lesson: Note that we are not going to make a bunch of predictions from our “theory” that people engage in conscious exchanges, and then go test these predictions against our observations of the world. No, you’ll see that all we’re really doing in this lesson is unpacking the knowledge that was already contained in the very notion of “purposeful action” in the first place. If you buy into the claim that we can usefully describe other people as engaging in goal-seeking behavior, then you will naturally understand our elaborations of that idea in the present lesson. On the other hand, if you tried to apply the concepts in this lesson to a purely mechanical process, such as a rock falling off a cliff, then it would be nonsense—because it just doesn’t seem helpful to explain a rock’s behavior as due to purposeful action.

Only Individuals Act

If we as economists are going to explain an event by referring to a purposeful action, this obviously implies that there is some individual performing the action. After all, to say that a conscious intelligence influenced events, implies that there must be some intelligent being to whom the consciousness belongs.

Now we don’t have to actually know the precise identity of the individual, in order to conclude that an individual has taken a purposeful action. A detective can look at a blood-soaked kitchen and say, “Somebody killed this poor woman—that butcher knife didn’t stab her through some freak accident.” The detective can thus explain the physical arrangement of the kitchen, by supposing that some other, intelligent individual consciously chose to act to kill the victim. This is a perfectly good hypothesis, even though the detective (as yet) doesn’t know anything else about the actual killer. But he does know that the killer had a goal in mind—no matter what the extenuating circumstances may be, nobody is going to believe him if he says, “Sure I was holding the knife when this happened, but believe me it was an accident.”

Just to make sure you really understand the concept, we note that the “individual” behind an action doesn’t necessarily need to be a human being. There are plenty of people who claim that their best explanation for what happened to them was that they were abducted by aliens and subjected to all sorts of unpleasant sensory experiences. Again, our rule holds: These people aren’t blaming “nature” for what happened, they are instead saying that intelligent beings influenced events. For whatever reason, the aliens had the goal of probing Billy Bob as he drove his pickup truck home one dark night, and the aliens acted on that desire. For a different example, a religious person might interpret the sudden remission of her cancer as due to the intervention of God. In this case, she too is explaining events in the physical world by reference to the purposeful action of an intelligent individual—one who in this case doesn’t possess a physical body.

When we decide to interpret an event as a purposeful action, we are necessarily supposing that there must be an intelligent individual carrying out the action. (There can’t be an action without an actor.) So the connection between an action and an actor is a logical one, flowing out of the very concept of “purposeful action” itself. Now in practice, our attempt to link up a specific action with a specific actor is based on more than simple logic. For example, when the detective decides “this is a homicide,” he is logically implying that there must have been (at least one) killer. But he might use faulty DNA tests to end up arresting the wrong guy. So we see, there is more than a logical deduction involved, when trying to arrest the actual killer. But the important point for our purposes is that the detective’s decision to classify a bloody kitchen as a crime scene necessarily means that there must be a killer (or killers). But going from this logical conclusion to the next step of identifying a particular person as the killer, requires more than mere logic.

To drive home the subtle interconnections of logical and empirical reasoning, we can consider a more fanciful example. Suppose a psychiatrist can see the left hand belonging to one of his patients as it grabs a pen and begins spreading ink onto a check. The psychiatrist classifies this as a purposeful action, and thus logically he must also believe that there is some conscious individual performing this action. However, the psychiatrist might think, “That’s my sweet patient Sally paying me for this week’s services as I help her with her split personality syndrome,” when in reality it is Sally’s alter-ego, Snippy, who isn’t filling out the check at all but instead is writing “YOU ARE TOO NOSY!!” on the paper before handing it over to him. In this example, we again have to keep in mind the limits of logical deduction. Once the psychiatrist decides to interpret the movements of the hand and pen as purposeful action—as opposed to a mere reflex—then he logically must conclude that there is an intelligent being with a motive who is moving the pen in order to achieve some goal. However, if the psychiatrist jumps to the conclusion that the intelligent being is the personality he knows as “Sally,” and that she is moving the pen in order to give him payment for his services, then the psychiatrist is going beyond the range of logical deduction, and he might be wrong.

As these examples illustrate, in everyday life we do a lot more than simply rely on logical deductions once we decide to interpret an event as a purposeful action. We use all sorts of empirical evidence to refine our understanding of what we observed. But economic theory focuses on the knowledge we can deduce merely from the fact of purposeful action itself, without the other empirical evidence in a given case that may or may not lead us to a fuller explanation.

Barring odd cases such as multiple personalities or hypnotic control, generally speaking we associate each human body with one specific mind (and vice versa). So when we see the physical body associated with “Bill” pouring a can of soda down its throat, we naturally describe this by saying, “Bill was thirsty so he decided to drink something.” Although we don’t usually stop to think about it, when we talk like this we are referring to an intangible, conscious will called “Bill” that tries to get its way by influencing the components of the glob of cells that we label, “Bill’s body.”

We are brushing up against deep philosophical issues once again, which go far beyond the scope of a book on economics principles. In this section, we only need to make one more point: Because a purposeful action is associated with a single individual (namely, the actor), it means that when an economist tries to explain an event by reference to purposeful actions, he ultimately must break it down into the motivations or goals of the individuals involved. This statement sounds obvious, but it is surprising how casually people—even respected social scientists—ignore the rule.

For example, an historian might write, “In 1941 Japan attacked the United States.” Strictly speaking, this is nonsense. “Japan” isn’t an individual and so can’t take purposeful actions (such as bombing Pearl Harbor). Individual Japanese pilots flew planes and attacked ships belonging to the U.S. Navy. The statement “Stalin occupied East Germany” is at least sensible (since Stalin is an individual), but it’s nonetheless misleading if interpreted literally. Really what happened is that Joseph Stalin gave orders to his subordinates, who in turn relayed them to their subordinates and so on, such that many many soldiers chose to obey those orders and carried out purposefulactions that resulted in a new (and scary) political situation for the people living in East Germany.

In many cases this sloppy use of language is fine; there is no danger of confusion when a sports fan yells out from his office cubicle, “Chicago just kicked a field goal to tie the game!” Everyone knows what he means by that statement; no one will be misled into believing that somehow a lifeless geographical location managed to block burly men long enough to propel a pigskin between two posts.

Only Individuals Act

The first truth to be discovered about human action is that it can be undertaken only by individual “actors.” Only individuals have ends and can act to attain them. There are no such things as ends of or actions by “groups,” “collectives,” or “States,” which do not take place as actions by various specific individuals. “Societies” or “groups” have no independent existence aside from the actions of their individual members. Thus, to say that “governments” act is merely a metaphor; actually, certain individuals are in a certain relationship with other individuals and act in a way that they and the other individuals recognize as “governmental.”

—Murray Rothbard, Man, Economy and State (Auburn, Ala.: Ludwig von Mises Institute, 2004), pp. 2–3

However, in many cases this sloppy use of language is very dangerous, leading people to reach the wrong conclusions about the world. For example, many people would endorse the following statement: “Man our government is so incompetent and dumb! On the one hand it pays farmers to grow tobacco, while on the other hand it pays ad agencies to develop anti-smoking campaigns. Make up your mind!”

In reality, there is no such thing as “the government” that has a mind of its own and can perform purposeful actions. Instead, there are individuals—politicians, judges, bureaucrats, etc.—belonging to the government who enjoy special privileges because of their status. Different combinations of (some of) these individuals make conscious decisions to steer tax dollars toward tobacco farmers and anti-smoking campaigns. The simplistic approach to viewing these programs as actions taken by “the government” is not only technically inaccurate, but it is actually dangerously misleading. After reading the lessons in this book, you will realize that there are perfectly sensible reasons for the actions of government officials. Their actions often don’t make any sense when compared to the official justifications given for the actions, but there’s a simple explanation for that too: government officials routinely lie. (Notice that lying is itself a purposeful action.)

Individuals Have Preferences

Besides the (obvious) point that an action requires an actor, we can draw further deductions. When we say that an individual performs a purposeful action, we mean that he has a purpose or a goal in mind. Remember, we don’t say that the baseball “wants to fall back to the ground.” But we would say, “The pilot landed the helicopter because he wanted to use the bathroom.”

So we see that when we discuss purposeful, intentional actions by others, we are implicitly saying that they have opinions or desires about how the world should unfold. In economics, we use the word preferences to describe these feelings; people act the way they do because they prefer the world to unfold one way, rather than another. For example, when we say, “Bill drank the soda because he was thirsty,” we are automatically also saying (even if we don’t speak the words), “... and Bill prefers to not be thirsty.” After all, it wouldn’t make much sense to say, “Bill drank the soda because 2+2=4.” The reason it does make sense to say, “Bill drank the soda because he was thirsty,” is that we can read between the lines, as it were, and fill in the unspoken claim that Bill is unhappy with his condition of being thirsty.

As you may have noticed, there is another unspoken truth that is packed into our simple statement about Bill’s chugging of the soda. When we decide to classify his behavior as a purposeful action, we are also deciding that Bill himself must believe that drinking soda can relieve thirst. After all, if a case of soda fell out of an airplane into a primitive village, the people who discovered it might have no idea that puncturing the hard shells and pouring the dark liquid into their mouths would relieve the unpleasant feelings of thirst. (And they certainly wouldn’t realize how much it would rot their teeth.) Instead, they might consider the cans sacred (since they fell from a giant flying object that they had never seen before), or their musicians might incorporate them into other forms of purposeful action, having nothing to do with thirst.

It’s important to realize that a person’s beliefs can be wrong, and yet still motivate a purposeful action. For example, if we went back in time and observed doctors in the 1800s placing leeches on patients, we would say, “They are doing that on purpose, because they prefer the patients to be healthy rather than sick, and because they believe that blood-letting is an effective treatment.” (On the other hand, someone armed with more accurate medical knowledge might place leeches on his enemy because he prefers him to be weak and he believes that drawing away blood will achieve this goal.)¹

We will develop the point more fully in the next lesson, but here we mention that people use parts of the world in order to achieve their goals. Philosophers describe this by saying people use means to achieve their ends. Economists describe this by saying people use goods and services to satisfy their preferences.

Preferences Are Subjective

Because preferences are tied to specific individuals, we say that preferences are subjective. Loosely speaking, the difference between a subjective versus an objective statement, is akin to the difference between an opinion versus a fact. It makes sense to say, “Mary prefers vanilla ice cream to chocolate, but John prefers chocolate ice cream to vanilla.” These two statements are perfectly compatible, because preferences (in this case, preferences for ice cream flavors) are subjective and can differ from person to person.

In contrast, it does not make sense to say, “The ice cream has 300 calories for Mary, but 280 calories for John.” The number of calories in a serving of ice cream is an objective fact; it can’t differ from person to person. Mary and John might disagree with each other about how many calories the ice cream has, but in that case at least one of them is simply mistaken. Yet both of them could be simultaneously “correct” when Mary says, “Vanilla tastes better than chocolate,” while John says the opposite. To repeat, Mary and John can disagree with each other about which flavor of ice cream tastes better—with neither one nor the other being wrong—because preferences are subjective. There is no “fact of the matter” concerning which ice cream tastes better, the way there definitely is an objective way to demonstrate how many calories are in a serving.

Warning! Many critics of economics—both from the progressive “left wing” as well as the religious “right wing”—totally misunderstand what economists mean by saying that preferences are subjective. These critics think that economists are somehow endorsing moral relativism, or that they are saying no one can judge the actions of anyone else. But these complaints are without merit, because economists aren’t saying those things at all!

Remember, we are simply tracing out the logical implications of our decision to classify observed behavior as purposeful action. If we see Mary go up to the counter and choose vanilla ice cream, while we see John go up to the counter and order chocolate, we won’t get anywhere in our understanding unless we realize that Mary and John have different tastes when it comes to ice cream flavors. As we will see more clearly in Lesson 6, the only satisfactory way to explain market prices is to first recognize that preferences are subjective. This recognition in no way condones the preferences of particular individuals.

For example, an economist can’t possibly explain the price of tobacco without acknowledging that some people prefer to spend their money on cigarettes, rather than on other products. After the economist states this fact, he can—with perfect consistency—then ground his teenage son when he catches him smoking in the garage with his hooligan friends. If you’re still not seeing the distinction between professional analysis versus personal beliefs, forget about economics and consider an FBI profiler. To track down a serial killer, the profiler needs to “think like the killer,” and try to understand what desires are causing the killer to act the way he is. Obviously this analysis doesn’t mean that the profiler is neutral with regard to the actions the killer takes, or that murder “is a personal choice.”

To sum up: When people engage in purposeful actions, they are motivated by desires that are not necessarily identical from person to person. In order to explain exchanges, economists must recognize that preferences are subjective.

Preferences Are a Ranking, Not a Measurement Using Numbers

Because preferences are tied to a person’s exchanges, the preferences can only reveal a ranking of goals. When Mary chooses vanilla over chocolate ice cream, this purposeful action only indicates that she prefers vanilla. We can’t determine “how much” Mary prefers vanilla over chocolate; indeed, that statement doesn’t even make sense in terms of strict economic logic.

In everyday conversation, we all know what it means to say that “Mary really prefers vanilla over chocolate but her sister Jane only slightly prefers vanilla to chocolate.” But it’s important for you to see that this type of talk makes no sense in terms of the preferences that we use in economic reasoning.²

After all, what does it really mean—from the standpoint of pure economic logic—to say that Mary has a preference for vanilla over chocolate? All it means is that, faced with a choice between the two flavors, Mary would pick vanilla. But that is the same thing we can say about her sister Jane, whose friends would testify that she has only a “slight” preference for vanilla. Jane too, when faced with a choice, would pick vanilla over chocolate. So in terms of logical deductions that we can make based on a person’s purposeful actions, all we can say as economists is that both girls exhibit a preference for vanilla over chocolate.

We can take this train of thought further to drive home the lesson. Even if Jane announces, “I just barely prefer vanilla to chocolate!” that wouldn’t give an economist the ability to conclude that her preference for vanilla is “less intense” than Mary’s. No, it would merely allow the economist to conclude that Jane preferred to yell that particular sentence, versus yelling something else or keeping her mouth shut. Remember, we are using the notion of a person’s subjective preferences to explain the concrete actions that the person takes. If someone utters a statement, that informs economists about the person’s preferences all right, but only because the utterance itself is a purposeful action!³

To help you remember the points of this lesson, consider the analogy of friendship. For example, Sally might have three friends, and so we could say that in her mind she holds feelings of friendship for each of them. We can push it further and ask Sally to rank her friends. She might say that Bill is her best friend, that Mary is her second-best friend, and that Joe is her third-best friend. Such talk is perfectly meaningful.

But what if we then asked Sally how much better a friend Bill was than Mary? Now things start to sound a little strange. And if we asked her, “Does Bill possess at least 30% more friendship than Joe?” we would have entered the realm of the absurd. The moral of this story is that it makes sense to rank friends, but even so there’s still no such thing as an objective “unit of friendship” behind the scenes, driving our ranking.

The same is true with preferences in general, at least as we use them in economics. As you will learn in upcoming lessons, to understand and describe exchanges, we need to assume that people have a ranking of goals or ends. People take actions to satisfy their most important preferences, or to achieve their highest goals. We do not have to say that people have a mathematical “utility function” that they seek to maximize, even though such talk is commonplace in other economics textbooks. This alternate approach is only useful in coming up with specific answers to contrived numerical problems; it doesn’t actually shed more understanding on the process of exchange. In fact, the use of mathematical utility functions is very harmful when learning basic economic principles, because it often causes the student to forget where the notion of preference comes from in the first place.

An Alternate View

Even professional economists do not always heed the principle that preferences are a ranking, not a measurement. For example, economists often use the term utility to describe how much pleasure or satisfaction a person gets from a particular situation. Therefore they might describe our scenario by saying, “Mary chose vanilla ice cream because it gave her more utility than the chocolate ice cream would have given her.”

So far, so good. But then many economics textbooks push it further and start assigning numbers to measure how much utility, so that (say) Mary gets “55 utils” from vanilla but only “34 utils” from chocolate, and so in order to “maximize utility” she obviously chooses the vanilla. If you are taking a Ph.D-level class, the textbook will explain that “utils” don’t really exist, the way “kilograms” are an objective unit of weight and “meters” are an objective unit of height. Instead, the Ph.D.-level textbook will explain, economists can use mathematical utility functions just as a convenient shortcut to describing preference rankings. So when the function assigns “55 utils” to a bowl of vanilla ice cream but only “34 utils” to the chocolate, all that really means is that Mary would choose the former over the latter. The utility function could just as well have assigned “18.7 utils” to the vanilla and “2.3 utils” to the chocolate; the important thing is that Mary acts “as if” she is maximizing this arbitrary mathematical function.

In this book, we will not be using the confusing terminology of “utils,” and we won’t be performing calculus on “utility functions” the way other economics textbooks do. These practices, though common, are dangerous because they can mislead you into thinking that we are measuring the amount of psychic satisfaction an individual derives from particular actions.

It may be that one day neuroscientists come up with an objective way to quantify various degrees of happiness, such that they can coherently talk about Mary being “three times more satisfied” than Bill. But even if this happens, our point here remains the same: In the field of economics, such talk is meaningless. In economics, we use terms like “preferences” as a way to explain or describe the purposeful actions of individuals. When someone chooses one thing over another, all we can conclude is that the person preferred the chosen item over the discarded item. Psychologists or neuroscientists (or even common sense) might shed more light on the event, but economic logic per se can go no further. The economist isn’t claiming to have all the answers; far from it! The economist is actually being humble here by admitting the limits of what economic reasoning can say about a given event. In Lesson 6, we will see how subjective preference rankings interact to yield objective market prices. At that time, you will understand better why we are stressing these points in this lesson.

Different Individuals’ Preferences Can’t Be Combined

If preferences are subjective to each individual, and cannot even be measured or quantified for each individual, then obviously it would make no sense at all to try to combine or aggregate individual preferences into “social” preferences. Unfortunately, even professional economists often engage in just this type of reasoning. Many people (try to) justify progressive income taxation, for example, by claiming that “a dollar means more to a poor man than to a rich man.” The idea is that taking $1 million from Bill Gates won’t lower his utility very much, whereas handing out $1,000 to a thousand different homeless people will greatly boost each of their utilities. Therefore, the typical argument goes, total or “social” utility has been increased by the redistribution of some of Bill Gates’s wealth.

In Lesson 18 we will examine the consequences of progressive income taxation. For now, we point out that the typical justification for it is absurd. You can’t add up different amounts of utility from various people. In fact, if you use the alternate term preferences it will be more apparent why combining them from different people is an impossible task. It makes sense to ask, “What is the total weight of the population?” or “What is the average age of the population?” It does not make sense to ask, “What is the total preferences of the population?” or “What is the average amount of utility per person?”

To make sure you understand just how nonsensical it is to (attempt to) perform arithmetical operations on different people’s preference rankings, once again let’s switch to the analogy of friendship. Suppose that Sally and Larry have the following “friendship rankings”:

Friendship Rankings

Before continuing, make sure you understand the table: Sally has five friends total. Her best friend is Bill, her second-best friend is Mary, and so on. Larry, on the other hand, only has two friends. His best friend is Joe, and Bill is his second-best friend. Notice that even among their shared friends, Sally and Larry don’t have the same ranking order. Sally thinks Bill is a better friend than Joe, while Larry thinks that Joe is a better friend than Bill. There is nothing strange about this, because preferences are subjective.⁴

Now suppose a busybody school administrator comes along and says, “This is terrible! Poor Larry doesn’t have as many friends as popular Sally! I have a great idea to make things fairer. I’ll write a note in Sally’s handwriting that says, ‘You smell!’ and put it in Adrian’s lunch bag. This will cause a big fight between Adrian and Sally, so he won’t be her friend anymore. Then I’ll arrange it so that Adrian sits near Larry on the school bus. They will eventually become friends. I can’t predict whether Adrian will become Larry’s 1st, 2nd, or 3rd-best friend, but no matter what, he will be ranked higher as a friend of Larry than he was as a friend of Sally. Through my benevolent intervention, I will have increased the total amount of friendship among the children.”

Obviously the above story is quite silly. But we have used a silly story to demonstrate the silliness of trying to add up subjective, individual preferences. Hopefully you can now see that trying to increase “social utility” by taking money from a rich man and giving it to a poor man, is simply nonsensical. Perhaps proponents of progressive taxation can justify it on other grounds, but appealing to the economic concept of preferences (or utility) doesn’t get the job done.

Lesson Recap...

• Once we decide to classify certain events as purposeful actions, we can make further logical deductions. For example, for every action there must be an actor, an intelligent person who performed the action. Although people can act in combination with each other, any particular action is performed only by one person.
• We interpret someone’s action by saying he or she has preferences. These are the goals that a person tries to achieve through actions.
• Economists say that preferences are subjective, meaning that they are unique to each person. To call preferences subjective doesn’t condone or applaud them, it simply recognizes that people have different tastes.

NEW TERMS

Preferences: An individual’s goals or desires. Economists interpret a person’s actions as attempts to satisfy his or her preferences.

Goods: Scarce physical items that an individual values because they can help to satisfy his preferences.

Service: A person’s performance of a task that another person values because it helps to satisfy preferences. Services are the “goods” that people create through their labor power.

Subjective: Unique to each individual; “in the eye of the beholder.”

Utility: A term common in economics textbooks to describe how much value a person gets from a good or service.

Progressive income taxation: A system that taxes individuals or corporations at higher rates based on the level of income.

STUDY QUESTIONS

1. Why is it questionable to say, “Germany attacked France”?
2. Why do statements about a man’s actions (implicitly) involve his beliefs as well?
3. Can purposeful action be based on a faulty belief? Give examples.
4. What does it mean when economists say preferences are subjective?
5. *Does economics say you shouldn’t give money to charity?