The Problem With Market Definitions

It is an article of faith in the US that the free market system is the best possible system for allocating scarce resources. Samuelson and Nordhaus have a long explanation of the glories of this kind of allocation. Economics 2005 ed. P. 26. One source for this idea is the early neoclassical economist William Stanley Jevons. He offers a mathematical proof that competitive markets will automatically generate the greatest utility for all participants in the market. The key words here are market and utility, and Jevons has a careful definition for both. His proof doesn’t work for non-competitive markets, but there is no such thing as a competitive market in the real world. Therefore, the proof doesn’t support the proposition that markets in the real world will produce the best possible allocation of scarce resources even in Jevons’ limited sense.

In his 1871 book, The Theory of Political Economy, available online here. Jevons taught that economics had to be based on physical sciences to achieve respectability.

But if Economics is to be a real science at all, it must not deal merely with analogies; it must reason by real equations, like all the other sciences which have reached at all a systematic character. IV.38

This was the view of the major neoclassical economists, including Léon Walras, Francis Edgeworth, Irving Fisher and Vilfredo Pareto, all of whom were trained in science, math and/or engineering. It is still the dominant view today, whether it’s Krugman with IS/LM, the Dynamic Stochastic General Equilibrium crowd scattered across the economic landscape, or any of the rest of the academic and business economists who dominate all discourse on the economy. All of them think math is the important thing. Thomas Piketty and his colleaguges, and the MMT group are notable exceptions.

The first step in a math-based program is definitions. Jevons is careful to define his terms, starting with the term “utility”, which is the subject of Chapter III. He quotes Jeremy Bentham’s definition from his Introduction to the Principles of Morals and legislation:

”By utility is meant that property in any object, whereby it tends to produce benefit, advantage, pleasure, good, or happiness (all this, in the present case, comes to the same thing), or (what comes again to the same thing) to prevent the happening of mischief, pain, evil, or unhappiness to the party whose interest is considered.”

This perfectly expresses the meaning of the word in Economics, provided that the will or inclination of the person immediately concerned is taken as the sole criterion, for the time, of what is or is not useful.

A commodity is a physical thing or service that embodies utility. Jevons explains at length the “fact” that the more you have of any commodity the less utility you derive from the last unit. Jevons uses the logic of the Riemann Integral to generate a downward sloping smooth curve based on the utility of the last unit. See III.17 and III.21. These figures depict the downward slope of the utility curve as more units of the commodity are acquired by the person.

Now suppose there are two people each with a supply of a single commodity. Jevons derives the following to show the conditions that determine the amount each will exchange with the other:

Jevons' Exchange Equation

Here, the symbol φ is the utility function for one commodity and ψ is the utility function for the other. The subscript 1 is for one person, and the subscript 2 is for the other. He says that each person will exchange until they reach the point point each person values the balance of their own commodity more than that of the other. Jevons is focused on straight up exchanges, corn for beef, but his equations work with money as well.

Finally, Jevons gives a careful definition of market in Chapter 4.

By a Market I shall mean much what commercial men use it to express. Originally a market was a public place in a town where provisions and other objects were exposed for sale; but the word has been generalised, so as to mean any body of persons who are in intimate business relations and carry on extensive transactions in any commodity. … The central point of a market is the public exchange,—mart or auction rooms, where the traders agree to meet and transact business. In London, the Stock Market, the Corn Market, the Coal Market, the Sugar Market, and many others, are distinctly localised; in Manchester, the Cotton Market, the Cotton Waste Market, and others. IV.15

For other definitions, see this post. In today’s language, we would call the people who make up Jevons’ market merchants. Here’s Jevons’ formal definition, my bold.

By a market I shall mean two or more persons dealing in two or more commodities, whose stocks of those commodities and intentions of exchanging are known to all. It is also essential that the ratio of exchange between any two persons should be known to all the others. It is only so far as this community of knowledge extends that the market extends. Any persons who are not acquainted at the moment with the prevailing ratio of exchange, or whose stocks are not available for want of communication, must not be considered part of the market. Secret or unknown stocks of a commodity must also be considered beyond reach of a market so long as they remain secret and unknown. Every individual must be considered as exchanging from a pure regard to his own requirements or private interests, and there must be perfectly free competition, so that any one will exchange with any one else for the slightest apparent advantage. There must be no conspiracies for absorbing and holding supplies to produce unnatural ratios of exchange. Were a conspiracy of farmers to withhold all corn from market, the consumers might be driven, by starvation, to pay prices bearing no proper relation to the existing supplies, and the ordinary conditions of the market would be thus overthrown. IV.16

Jevons connects his utility and market definitions through his Law of Indifference:

…[W]hen two objects or commodities are subject to no important difference as regards the purpose in view, they will either of them be taken instead of the other with perfect indifference by a purchaser. Every such act of indifferent choice gives rise to an equation of degrees of utility, so that in this principle of indifference we have one of the central pivots of the theory.

The connection is that in a perfect, or what we would call a competitive, market when dealing with commodities that are utterly alike, we can predict that people will exchange commodities to increase their utility, and will continue to exchange until further exchanges would decrease their total utility.

After some examples, and acknowledgement of various problems with his equations, Jevons draws the following conclusion:

But so far as is consistent with the inequality of wealth in every community, all commodities are distributed by exchange so as to produce the maximum of benefit. Every person whose wish for a certain thing exceeds his wish for other things, acquires what he wants provided he can make a sufficient sacrifice in other respects. IV.98

This conclusion springs directly from his definitions of market and utility. There are serious questions as to whether either definition is a good one, but the definition of market must describe some alternative planet. At the time Jevons was writing, financial markets and commodity markets were infested with fraud and corruption. Jevons acknowledges the problems of availability of information to participants, and the unfairness associated with speculators. IV.18. The average consumer bought in street markets, which probably match his definition fairly well for everyday items.

No one really thinks commodity and financial markets are much better today than they were in Jevons’ day. For consumers, the problem is worse. There is no bargaining in grocery stores or department stores or with Amazon. There is no bargaining with cable companies or health care providers or insurance companies or banks or any provider of necessary items. The consumer is the price taker, and with the purchase takes all the legal limitations the seller can impose. Even for savers, there is no protection from stock brokers who owe no fiduciary duty to anyone but themselves.

Samuelson and Nordhaus use language very similar to Jevons to explain utility and marginal utility and to explain consumer behavior, to the point of quoting him. Economics, 2005 ed. Ch. 5. It’s reasonably true that individual consumers try to maximize their utility from the goods and services they buy, subject, of course, to their ability to understand the transaction, and to determine correctly the utility of the goods and services, as compared to other choices, including the choices to save or pay down debt. Samuelson and Nordhaus don’t claim that consumers always make good choices. P. 89. They do claim that consumers make reasonable choices and learn from their errors, and that’s close enough for their theory, they say. I wonder how many billions of dollars fall into that web of cracks in the market façade.

But Samuelson and Nordhaus separated their definition of market from their definition of utility, so it isn’t obvious to the student that the markets themselves are inadequate tools for determining price/utility ratios that consumers face. In fact, the problems with those markets means that consumers can only maximize their utility to a certain level, and the people and firms that control the markets will always suck up the rest of that utility for themselves. We don’t trade in utility, so that means they suck up more consumer money.

To be clear, most economists probably have a more sophisticated view of markets than we see in Jevons and in Samuelson and Nordhaus, and probably understand the limitations of the notion that the market system produces the best possible allocation of scarce resources.

But that sophisticated view is saved for grad students. The public, even the college-educated public, is fed on Jevons. That is why I think the definition of market matters. If economists had to teach the imagined better theory in Econ 101, the cracks and strains of the current system would be apparent.

18 replies
  1. TarheelDem says:

    Jevons sets up a simple two-party, two-commodity “market” and predicts the relationships between price and quantity. Has that model, even at this simple and abstract level, in fact been proved out by behavioral economists?

    That is, is the whole marginal utility part of Jevons’s theory even valid? Or does it still depend for acceptance on its being somewhat intuitive if one is socialized in a capitalist system?

    • Ed Walker says:

      That’s a great question. I haven’t seen such a study, and it does seem like there should be some effort to find out. There are, of course, loads of studies that show that people don’t make good choices about lots of things, and as I noted, Samuelson and Nordhaus admit this.

  2. bloopie2 says:

    Lots of food for thought here. I do have one question. You note near the end: “No one really thinks commodity and financial markets are much better today than they were in Jevons’ day. For consumers, the problem is worse. There is no bargaining in grocery stores or department stores or with Amazon. There is no bargaining with cable companies or health care providers or insurance companies or banks or any provider of necessary items.”
    But isn’t there a benefit to the consumer, from the grocery store, that goes along with that detriment? After all, how many of us are today able to go out and accumulate the needed (or desired) hundreds of items we purchase there, other than at the grocery store? We need (want) one-stop shopping, and the loss of bargaining power as to cost per item, is the price we pay for getting that benefit. Aren’t we getting what we want? And if we are getting what we want, then why say that the problem is “worse” than in the old days when we had to go to a dozen different places, over the course of a day or so, to get all the different things we needed?

    • Ed Walker says:

      Well, the point of the post is that markets and a free market economy are supposed to insure that utility is maximized for everyone. Here I look at the issue around markets, and show it is unlikely to be true. The question you ask, are there offsetting benefits, is interesting, but the fact is that the rich keep getting richer, so I’m guessing the markets are benefiting the rich a lot more than any benefit we consumers might realize. In a truly competitive market that would eventually go away, but it doesn’t.

  3. Anon says:

    Thank you.
    This piece actually helped to explain a very puzzling argument I kept having with one of my libertopian friends. I kept noting that the assumption that markets would be the best for everyone has never worked out in practice. He kept replying that “we hadn’t done it yet” but once we deregulated everything it would happen.
    That article of faith made no sense to me but now I see that it wasn’t him it has a long history in economics.

  4. chris miller says:

    I had to take Samuelson at MIT back in the day – 14.01 not Econ 101. Even to me as a freshman it was clear that stuff was ungrounded. My big MIT regret was not knowing (with years later foresight) I could have gone up the river to take equiv credits with JKGalbraith. Bottom line, which this article dances around but avoids concluding, is that there are no “markets”; the game is rigged and for anyone outside the 1/2 of 1%, that matters more than anything else. That’s been pretty obvious for a while. Presumably obvious to Samuelson and his like as well. Assholes like that should not be teaching freshmen. Or rather, maybe why they SHOULD. Depends on where one stands and what sort of graduates one wants.

    The “better people” are taking everything and paying for it with live ammunition, poison food and sham “justice”. What’s the utility function where one group of people is better than another? Classified by NSA/CIA – that’s what the War on Terror is really about. Rule of Man vs Rule of Law.

    And it’s what the economics profession advocates: if one can pay for corruption, then surely that is what the market validates. QED – can’t be wrong. Corn pone, Mark Twain would suggest. Dovetail.

    • bloopie2 says:

      Were the markets fixed even when we didn’t have so much income inequality? When unions were strong in the US? Always, going back in time? Just curious.

    • greengiant says:

      Housing market?, Just go back to George Washington’s speculations in the Ohio river valley and go backwards or forwards in time and then try to talk about “market”. You might also talk to anyone who has bought or sold personal real estate as to their view of the “market”.

      • Bay State Librul says:

        The Massachusetts real estate market is red hot. Demand is outpacing supply, the dynamics of market forces is working.
        In Florida, the market is getting better, but supply outpaces demand, so it’s a buyers market.
        Willing buyers and sellers in the marketplace.
        What’s not to love?

        • greengiant says:

          dynamics … working…. No doubt the same was said about the tulip bulb market. In recent history we have cases where mortgage brokers have slammed buyers into sub prime loans because that is where the commissions and wall street demand was. Real estate in the US is affected by a number of monopoly and oligopoly participants each adding their burden to development, resales and construction, as well as passing costs onto government and others.
          The purchase of local governments by developers does not define a “market”.

          • Bay State Librul says:

            I’m talking basically residential resales.
            Do you own a home?
            If so, when you bought, did you feel you were paying the market price?

  5. Alan says:

    Economists’ mathematical models of ‘the market’ don’t make the discipline a “real science”, such as physics, because the social practices that make economics possible are internal to the the topic of study. This is true for all the social sciences. Economists’ models aren’t purely descriptive; they are constitutive of economic relationships. That is why the history, philosophy, anthropology and sociology of economics are so important. They provide the means to expose the discipline’s contextuality and resist its universalizing, totalizing ideology.

    • Ed Walker says:

      I agree, and so does Piketty. I will post a definition of market soon, I hope, one that gets to this point.

  6. jonf says:

    Geez, I saw that formula and figured they have reduced me to mathematics, quantum mechanics I guess. Bunch of really smart guys disappeared into this café and…. Are they here or there, dead or alive????

  7. Alan says:

    More on critique of the universalizing and totalizing ideology that is neoclassical economics:

    A “sophisticated view” of markets is dependent on getting rid of the impoverished and impoverishing view that humans are rational utility maximizers. This view of humanity, as Marshall Sahlins notes, has been endlessly ridiculed but lives on, apparently no matter what. (When you can take a a spin through the revolving door connecting corporate-funded academic departments, WallStreet and government you’re probably immune to the ridicule of other disciplines.)

    One would think the whole discipline [modern economics] had been mortally wounded by the critical attacks of its own practitioners—let alone the likes of anthropologists—on its abstract, unrealistic, post-hoc, pseudo-scientific, fantastic, fetishistic, Platonic, chimerical, rhetorical, ideological, non-empirical, teleological, metaphorical, tautological, mythological, and otherwise louche theoretical propositions. Here is a brave, new “invented world of the eighteenth century” that has no actual people in it (Servet 2009: 88). Rather, it is populated solely by this “rational fool” Homo Economicus (Sen 1977: 336): a “character without character” (Klamer 2001: 93); an impulsive, manipulative, and shallow sociopath (McCloskey 2006: 135), whose single-minded pursuit of his own pleasure or gain by the rational central illusion of our age” (Polanyi 1997: 5; cf. 1947). “Few textbooks contain a direct portrait of rational economic man,” write Martin Hollis and Edward Neil (1975: 53–54):
    “He is introduced furtively and piece by piece. . . . He lurks in the assumptions, leading an enlightened existence between input and output, stimulus and response. He is neither tall nor short, fat nor thin, married nor single. There is no telling whether he loves his dog, beats his wife or prefers pushpin to poetry [pushpin to Pushkin?]. We do not know what he wants. But we do know that whatever it is, he will maximize ruthlessly to get it.”
    Problem is, of course, with the commodification of everything, thus mystifying cultural facts as pecuniary values, the notion that the cultural order is the effect of people’s economizing, rather than the means thereof, became the native bourgeois common sense as well as its social science.

    Sahlins, Marshall. “On the Culture of Material Value and the Cosmography of Riches.” HAU: Journal of Ethnographic Theory 3, no. 2 (September 17, 2013).

    Another anthropologist worth reading is Chris Gregory. He provides a nice sketch of the history of classical and neoclassical and economic anthropology in Gregory, C. A. “Anthropology, Economics, and Political Economy.” History of Political Economy 32, no. 4 (2000). This article is maybe a little more accessible to the non-anthropologist than the one cited above.

    The human being is a very complex character who not only works in a factory, shops, and gives generously upon occasion; he or she also does many other things of economic significance. How can one theory of value hope to grasp the complexity of these daily actions? The complexity of the human condition calls for a large dose of theoretical humility, but this, alas, is hard to find, especially in the dominant marginal utility theory paradigm. Value theorists need to perceive the limits to the generality of their particular theory. This requires them to accept that the economy, both market and nonmarket, has varied over time and place, and that ideas about the functioning of the economy reflect this geographical and historical variation. Whenever one group or another claims universality for their particular theory of value there can be no dialogue.

    For an example of an unabashed lack of “theoretical humility” in an exponent of the dominant paradigm see: Lazear, Edward. “Economic Imperialism.” The Quarterly Journal of Economics 115, no. 1 (2000): 99–146. (From 2006 – 2009 Lazear was chairman of the President’s Council of Economic Advisers.) Note that in this article the author manages to mangle both Adam Smith and the so-called Coase Theorem, par for the course in neoclassical economics.

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