kapteyn arie - utility and economics

7/30/2019 Kapteyn Arie - Utility and Economics

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D E E C O N O M I S T 1 33 , N R . l , 1985

U T I L IT Y A N D E C O N O M I C S * *B Y

A R I E K A P T E Y N *

1 I N T R O D U C T I O N

' U t i l it y ' h a s b e e n t h e c e n t r a l c o n c e p t in e c o n o m i c s f o r a l o n g t i m e . S e e , f o re x a m p l e , S t ig l e r ( 19 50 ) f o r a n e x c e l l e n t r e v i e w o f t h e h i s t o r y o f t h e c o n c e p t o fu t i l i t y i n e c o n o m i c s . T h e r e h a v e b e e n v a r i o u s a t t e m p t s t o u n d e r m i n e t h ep o s i t i o n o f t h e u t i l i t y c o n c e p t . T h e m o s t f a m o u s i s p r o b a b l y S a m u e l s o n ' st h e o r y o f r e v e a l e d p r e f e r e n c e , w h i c h w a s a n a t t e m p t t o g e t r id o f 'u t il i ty ' f o rg o o d . ~ D u e t o H o u t h a k k e r (1 95 0), w e k n o w n o w t h a t r e v e a l e d p r e f e r e n c etheory i s bas ica l ly equ iva len t to neoc las s ica l cho ice theo ry . Thus , a t p resen tt h e u t i l it y c o n c e p t is m o r e i m p o r t a n t t h a n e v e r in e c o n o m i c th e o r y .

S t i l l , economis t s have a somewhat ambiguo t l s a t t i tude towards u t i l i ty ,w h i c h i s e x e m p l i f i e d m o s t c l e a rl y b y th e w a y in w h i c h t h e y t r y t o e n h a n c e t h e i re m p i r ic a l k n o w l e d g e o f u t il it y . A s a ru l e , m e a s u r e m e n t t a k e s p l a c e i nd i r e c t l y ;a s k in g p e o p l e q u e s t i o n s a b o u t t h e i r u t il it y is c o n s i d e r e d t o b e f r u it le s s . T h eo n l y w a y in w h i c h e c o n o m i s t s a ll o w t h e m s e l v e s t o l e a r n a b o u t u t il it y f u n c t io n so f e c o n o m i c a g e n t s is b y o b s e r v in g t h e i r b e h a v i o u r . T h i s s e lf - re s t ra i n t w i thr e s p e c t t o t h e m e a s u r e m e n t o f t h e c e n t r a l c o n c e p t o f th e i r d i s c ip l in e t~ as f a r-r e a c h i n g c o n s e q u e n c e s f o r t h e n a t u r e o f e c o n o m i c t h e o ri z in g . I n th i s p a p e r , Iw i ll d i sc u s s s o m e o f t h e s e c o n s e q u e n c e s .

2 W H A T IS U T IL I T Y ?'U t i l i ty ' is roug h ly syno nym ous w i th 's a t i s f ac t ion , ' 'we l l -be ing , ' 'we l f a re , '' h a p p i n e s s , ' ' p l e a s u r e , ' etc. G e n e r a l l y , w e c a n i n c re a s e o u r u t il it y b y u n d e r t a k -i n g e n j o y a b l e a c t i v i t i e s o r p u r c h a s i n g t h i n g s w e d e s i r e . I n t h e w o r d s o fB e n t h a m (1 82 3, p . 3 ): ' B y u ti li ty is m e a n t t h a t p r o p e r t y i n a n y o b j e c t , w h e r e b yi t t e n d s t o p r o d u c e b e n e f i t , a d v a n ta g e , p l e a s u r e , g o o d o r h a p p i n e ss . . . ' O fcou r se , th i s desc r ip t ion i s r a the r too loo se to s e rve as a de f in i t ion . T o Ben tha rna n d h i s c o n t e m p o r a r i e s ' u ti li t y ' w a s a p r i m i t i v e t e rm . T h a t is , t h e y a p p e a r e d t o* P r o f e s s o r o f E c o n o m e t r i c s , T i lb u r g U n i v e r s it y , t h e N e t h e r la n d s .* * T h i s i s a sl ig h t ly a d a p t e d v e r s i o n o f m y i n a u g u r a l a d d r e s s a t T i l b u r g U n i v e r s i t y . I t h a n k T o mW a n s b e e k f o r hi s h e l p f u l c o m m e n t s .1 S a m u e l s o n ( 19 38 , p . 6 2 ): ' I p r o p o s e , t h e r e f o r e , t h a t w e st a r t a n e w in d ir e c t a t t a c k u p o n t h ep r o b l e m , d r o p p i n g o f f t h e l a s t v e s t i g e s o f t h e u t i li ty a n a l y s i s .'


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2 A. KAPTEYNa g r e e o n t h e m e a n i n g o f ' u t i li t y , ' w i t h o u t a n e x a c t d e f in i t i o n b e i n g n e c e s s a r y .

I n m o d e r n e c o n o m i c t h e o r y , t h is is n o t t h e c o m m o n w a y t h e u ti li ty c o n c e p tis i n t r o d u c e d . N o w a d a y s t h e preference ordering is t a k e n a s a p r i m i t iv e t e r m .A n i n d i v id u a l ' s p r e f e r e n c e o r d e r i n g r a n k s a l te r n a t iv e s i n o r d e r o f p r e f e r e n c e .I f t w o i n d i v i d u a l s e x p r e s s t h e s a m e p r e f e r e n c e i n e a c h c o n c e i v a b l e d e c i s io ns i t u a t i o n , t h e i r p r e f e r e n c e o r d e r i n g s a r e i d e n t i c a l. I f , h o w e v e r , g i v e n a c h o i c eb e t w e e n g o i n g t o a s o c c e r g a m e a n d a t t e n d i n g a c o n c e r t o f c la s si ca l m u s i c , o n ei n d i v i d u a l c h o o s e s t h e s o c c e r g a m e a n d t h e o t h e r o n e p r e f e r s t h e c o n c e r t , th e nt h e i r p r e f e r e n c e o r d e r in g s a r e d i f f e re n t .

O n e w o u l d e x p e c t t h a t , i n m a k i n g d e c i s io n s , a n i n d i v i d u a l w i ll t r y toe n h a n c e h i s u t i li ty . I f I e x p r e s s a p r e f e r e n c e f o r a s o c c e r g a m e o v e r a c la s si c alc o n c e r t , t h e n i t s e e m s r e a s o n a b l e t o i n f e r t h a t m y u t i li ty w i ll b e h i g h e r w h e n Iv is it t h e g a m e t h a n w h e n I a t t e n d t h e c o n c e r t. I f n o t , w e w o u l d h a v e s o m ed o u b t a b o u t t h e u t il it y c o n c e p t u s e d , o r t h e c o n c e p t o f p r e f e r e n c e w o u l d b eu s e d i n a s o m e w h a t p ~ r v e r se m a n n e r . I n e c o n o m i c t h e o r y , s u c h a p e r v e r s er e l a t i o n s h i p b e t w e e n u t i li t y a n d p r e f e r e n c e c a n n o t o c c u r , b e c a u s e ' u t il i ty ' isdef ined s u c h t h a t a p r e f e r r e d a l t e r n a t i v e a l w a y s r e p r e s e n t s a h i g h e r u t il it y l e v e l( o r a t l e a s t n o t a l o w e r o n e ) t h a n t h e r e j e c t e d a l t e r n a t i v e . ' U t i l it y ' is n o l o n g e ra p r im i t iv e t e r m , b u t i t is d e f i n e d i n te r m s o f p r e f e r e n c e s .

A n e x a m p l e m a y c l a ri fy t hi s: m i c r o e c o n o m i c m o d e l s o f c o n s u m e r b e h a v i o u rd e s c r ib e h o w p e o p l e c h o o s e f r o m d i f f e r e n t c o n s u m p t i o n b u n d l e s . I t is c o m -m o n l y a s s u m e d t h a t c o n s u m e r s a r e a b l e t o r a n k a l l r e l e v a n t a l t e r n a t i v e s i no r d e r o f p r e f e r e n c e . A u t il i ty f u n c t i o n , i.e . a r e l a t i o n s h i p t h a t t e ll s u s f o r a n yc o n s u m p t i o n b u n d l e h o w m u c h p l e a s u r e t h e c o n s u m e r d e ri v es fr o m i t, h a s t os a ti sf y t h e r e q u i r e m e n t t h a t i t a g r e e s w i th t h e c o n s u m e r ' s p r e f e r e n c e o r d e r i n g ,in t h e s e n s e t h a t e a c h t i m e t h e c o n s u m e r p re f e r s b u n d l e A t o b u n d l e B , t h eu t i li t y f u n c t i o n t e l ls u s th a t A g i ve s m o r e u t i li ty t h a n B . U n d e r r a t h e r p l a u s i b lea s s u m p t i o n s c o n c e r n i n g t h e s t r u c t u r e o f a c o n s u m e r ' s p r e f e r e n c e o r d e r i n g , i tc a n b e s h o w n t h a t s u c h a u t i l it y f u n c t i o n e x i s ts ( s e e , e.g., D eb re u , 1959). I t i st h e n s a i d t h a t t h e u t i li t y f u n c t i o n represents t h e p r e f e r e n c e o r d e r in g .

F o r t h e s i m p l e s t ca s e , w h e r e o n l y q u a n ti t i e s o f o n e g o o d h a v e t o b e c o m -p a r e d , t h e u t i li t y f u n c t i o n c a n b e d r a w n i n a s im p l e d i a g r a m , a s in F ig . 1, w h i c hd e p i c t s u t i l it y f u n c t i o n s o f i n c o m e o f t h r e e d i f f e r e n t i n d i v id u a l s . 2

3 ON ORDINAL AND CARDINAL MEASURABILITYL o o k i n g a t F i g . 1, w e n o t i c e t h a t e a c h o f t h e i n d i v i d u a l s p r e f e r m o r e i n c o m e t ol es s. I n o t h e r w o r d s , e a c h t i m e t h e y h a v e a c h o i c e b e t w e e n t w o i n c o m e l e v e ls ,e a c h i n d i v i d u a l c h o o s e s t h e h i g h e r i n c o m e l e v e l . S o , w i t h r e s p e c t t o i n c o m et h e t h r e e i n d i v i d u a l s h a v e i d e n t i c a l p r e f e r e n c e o r d e r i n g s . ' M o r e is b e t t e r t h a nl e s s. ' A s a r e p r e s e n t a t i o n o f a p r e f e r e n c e o r d e r i n g t h e t h r e e u t i li ty f u n c t i o n sa r e h e n c e e q u i v a l e n t . I n s t a n d a r d e c o n o m i c p a r l a n c e , w e s a y t h a t ' u t i l it y ' is a n2 In this paper , 'i ncome' is defined throughout as annual after tax disposable income.


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U T I L I T Y A N D E C O N O M I C S 3u t i l i t yr u / y / ]

J n d J v i d u a l i n d i v i d u a l

i n c o m e ( y }F i g u r e 1 - U t i l it y f u n c t i o n s o f i n c o m e o f t h r e e i n d i v i d u a l s

o r d i n a l c o n c e p t : T h e n u m b e r s o n t h e v e r t i c a l a x i s a r e a r b i t r a r y . T h e o n l yrequ i remen t i s tha t a h igher u t i l i ty l eve l i s a s soc ia ted w i th a h igher number .O n l y t h e o r d e r i n g o f t h e n u m b e r s o n t h e v e r t ic a l ax is c o u n t s , n o t t h e i r v a lu e .

A l t h o u g h F i g . 1 r e f e r s t o t h e s i m p l e s t p o s s i b l e c a s e w h e r e o n l y q u a n t it i e s o fo n e g o o d ( i n c o m e ) a r e c o m p a r e d , t h e s a m e c o n c l u si o n h o ld s f o r s i tu a t i o n s inw h i c h o n e h a s t o c h o o s e b e t w e e n b u n d l e s o f g o o d s . C o n s i d e r , f o r e x a m p l e , t h ec a s e o f a m a n w h o s e l u n c h c o n s i st s o f o n l y t w o i n g r e d ie n t s , w a t e r a n d b r e a d .H e is a b l e t o r a n k a ll w a t e r / b r e a d c o m b i n a t i o n s in o r d e r o f p r e f e r e n c e .A s s u m e t h a t w e a r e a b l e t o f i n d a u t i l i t y f u n c t i o n w h i c h r e p r e s e n t s t h i sp r e f e r e n c e o r d e r i n g , i .e . , i n e a c h p a i r- w i s e c o m p a r i s o n o f w a t e r / b r e a d b u n d l e sthe p re fe r r ed bund le has the h ighes t u t i l i ty . I t i s then ve ry s imple to f inda n o t h e r u t il it y f u n c t i o n r e p r e s e n t i n g t h e s a m e p r e f e r e n c e o r d e r i n g , f o r e x a m -ple b y mu l t ip ly ing a ll u t i l i ty levels h igh er than 10 by 100 and by d iv id ing a l lu t i l ity l eve l s be low 10 by 100. Th is t r ans fo rm at ion doe s no t a f f ec t the o rde r ingof u t i l i ty l eve l s .

C l e a r l y , t h e p r e f e r e n c e o r d e r i n g c o n t a i n s a l l t h e i n f o r m a t i o n w e n e e d t oe x p l a i n ( o r p r e d i c t ) c o n s u m e r c h o i c e . T h is is b e c a u s e th e p r e f e r e n c e o r d e r i n gt e ll s u s , fo r e a c h s i t u a t io n , w h i c h c o n s u m p t i o n b u n d l e i s p r e f e r r e d . H e n c e w ec a n p r e d i c t t h e c o n s u m e r ' s c h o i c e in e a c h s it u a t io n . S i n c e, i n t u r n , a n o r d i n a lu t i li t y f u n c t i o n p r o v i d e s u s w i t h c o m p l e t e i n f o r m a t i o n a b o u t t h e c o r r e s p o n d -ing p re fe rence o rde r ing , i t a l so p rov ides a l l in fo rmat ion tha t i s neces sa ry toe x p l a i n b e h a v i o u r .

T h e c o n c l u s i o n t h a t a n o r d i n a l u t il it y fu n c t i o n s u f fi c e s t o e x p l a i n b e h a v i o u rw a s f i rs t d r a w n b y F i s h e r a n d P a r e t o a t t h e t u r n o f t h e c e n t u r y . S i n ce t h e n ,o rd ina l u t i li ty has do m ina ted eco nom ic the o ry ( c f. S t ig le r , 1950).O r d i n a l m e a s u r a b i l i t y is a r a t h e r w e a k p r o p e r t y . A l t h o u g h s o m e o n e ' s u t il it yfunc t ion can t e ll u s tha t th is ind iv idua l p re fe r s on e l i t e r o f w a te r and 5 s l ices o fb r ea d to ha l f a l i te r o f w a te r an d 6 s li ces o f b read , i t can no t t e ll u s any th inga b o u t u t i l i t y d i f f e r e n c e s . W e d o n o t k n o w w h e t h e r t h e u t i l i t y d i f f e r e n c e


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4 A . K A P T E Y Nb e t w e e n 1 l i t e r o f w a t e r a n d 5 s li ce s o f b r e a d a n d h a l f a l i te r o f w a t e r a n d 6 sl ic e so f b r e a d e x c e e d s t h e u t i li t y d i f f e r e n c e b e t w e e n h a l f a l i t er o f w a t e r a n d 6 s li ce so f b r e a d a n d h a l f a l i te r o f w a t e r a n d 5 s li ce s o f b r e a d . I t t h a t w e r e p o s s i b l e ,u t il it y w o u l d b e s a id t o b e m e a s u r a b l e o n a cardinal scale.O f c o u r s e , t h e f a c t t h a t a n o r d i n a l l y m e a s u r a b l e u t i li t y c o n c e p t su f f ic e s t od e s c r i b e e c o n o m i c c h o i c e s 3 d o e s n o t i m p l y t h a t c a r d in a l m e a s u r e m e n t isi m p o s s i b l e . S t i ll , t h is a p p e a r s t o b e th e c o n c l u s i o n w h i c h m o s t e c o n o m i s t s h a v ed r a w n f r o m F i s h e r ' s a n d P a r e t o ' s a n a l y s e s .

T h e s u p p o s i t i o n t h a t u t i li ty ca n o n l y b e m e a s u r e d o n a n o r d i n a l s c a le h a sd i r e c t c o n s e q u e n c e s f o r o u r c a p a c i t y t o l e a r n s o m e t h i n g a b o u t u t i l i t y . T oi l l u s tr a t e t h i s, l e t u s r e c o n s i d e r F ig . 1 . A p p a r e n t l y , i t d o e s n o t m a k e s e n s e t oa s k s o m e o n e w h a t u t i l i ty l e v e l h e a t t a c h e s , f o r e x a m p l e , o n a [0 ,1 ] s c a le , t o a ni n c o m e o f s a y , 75 ,0 0 0 g u il d e rs . T h e t h r e e g r a p h s a r e e q u i v a l e n t r e p r e s e n -t a t io n s o f t h e s a m e p r e f e r e n c e o r d e r i n g . Y e t t h e y g e n e r a t e q u i t e d i f fe r e n ta n s w e r s t o t h e a b o v e q u e s t i o n . A l s o t h e r e v e r s e q u e s t io n , w h i c h i n c o m ec o r r e s p o n d s t o a c e r t a i n p o i n t o n t h e u t i li t y s c a le , d o e s n o t m a k e s e n s e . S o , t h em e a s u r e m e n t o f u t i li t y f u n c t i o n s b y m e a n s o f d i r e c t q u e s t i o n i n g ( I w il l c a ll t h is' d i r e c t m e a s u r e m e n t ' ) is i m p o s s i b l e i f u t il it y c a n o n l y b e m e a s u r e d o n a no r d i n a l s c a l e .

I n d e e d , t h e p r e v a i li n g o p i n i o n a m o n g e c o n o m i s t s a p p e a r s to b e t h a t d i re c tm e a s u r e m e n t o f u t il i ty is im p o s s i b l e . T h i s is n i c e l y i l l u s tr a t e d b y r e f e r e er e p o r t s B e r n a r d v a n P r a a g a n d I h a v e r e c e i v e d w i t h re s p e c t to o n e o f o u rp a p e r s . 4 O n e r e f e r e e s ta te s : ' U n l i k e t h e a u t h o r s , I a m v e r y d u b i o u s o f t h ee x t e n t t o w h i c h w e c a n l e a r n a n y t h i n g u s e fu l b y a s ki n g p e o p l e h o w h a p p y t h e ya r e , o r w h a t l e v e l o f i n c o m e w ill m a k e t h e m h a p p y t o a c e r ta i n d e g r e e . ' A n dt h e s e c o n d r e f e r e e a d d s: ' . . . t h e a u t h o r s - l ik e e v e r y o n e e ls e - d o n o t a n dc a n n o t m e a s u r e u t i li t y d i r e c tl y . ,5

N o w a s s u m e f o r a m o m e n t t h a t i n d e e d u ti li ty ca n o n l y b e m e a s u r e d o n a no r d i n a l s c a le . S t il l, o u t o f m e r e s t u b b o r n n e s s , w e a sk a r e s p o n d e n t i n a s u r v e yw h i c h i n c o m e h e a s s o c i a t e s w i t h a u t i l i t y l e v e l o f , s a y , 0 . 5 o n a [0 ,1 ] s c a l e . W h a th a p p e n s t h e n ? A c c o r d i n g t o o u r a s s u m p t i o n s , t h e r e s p o n d e n t fa c e s a n i m p o s -s i b l e t a s k . P s y c h o l o g i s t s m a y b e a b l e t o p r e d i c t w h a t t h e r e s p o n d e n t w i l l d on e x t ; m a y b e h e f la t ly r ef u s e s to a n s w e r t h e q u e s t i o n , o r h e m a y e x p r e s s a l o wo p i n i o n a b o u t t h e i n t e r v i e w e r ' s i n t e l l i g e n c e , o r h e m a y b e c o m e a g g r e s s i v et o w a r d s t h e i n t e r v i e w e r o r s i m p l y t h r o w h i m o u t .

I d o n o t k n o w w h e t h e r B e r n a r d v a n P r a a g w a s a w a r e o f t h e s e a n d o t h e r r is k sw h e n h e s t a r t e d a s k in g p e o p l e w h i ch i n c o m e l e v el s t h e y a s s o c ia t e w i th v e r b a l l y3 I i g n o r e c h o i c e s i n u n c e r t a i n o r d y n a m i c s e t ti n g s . I n t h e s e c as e s a c a r d i n a l u t i li t y c o n c e p ta p p e a r s t o b e n e c e s sa r y . S e e , f o r i n s t a n c e , V o n N e u m a n n a n d M o r g e n s t e r n ( 19 44 ), a n d K o o p -mans (1972) .4 ' A N e w A p p r o a c h t o th e C o n s t r u c t i o n o f F a m i l y E q u i v a l e n c e S c a le s .'5 T h e p a p e r w a s e v e n t u a l ly a c c e p te d f o r p u b l i c a t io n , b u t n o t b y t h e j o u r n a l f o r w h i c h th e s er e f e r e e s a c t e d .


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UTILITY AND ECONOM ICS 5l a b e l l e d u t i l i ty l e v e ls li k e ' e x c e l l e n t , ' ' g o o d , ' ' s u f f i c i e n t , ' e t c . ( V a n P r a a g ,1 97 1). S in c e h e s t a r t e d , t h e s e k i n d o f q u e s t io n s h a v e b e e n p o s e d t o a b o u t5 0 ,0 0 0 r e s p o n d e n t s i n d i f f e r e n t c o u n t r i e s a n d i t a p p e a r s t h a t a t t e m p t s a t d i r e c tm e a s u r e m e n t o f u ti li ty fu n c t io n s o f i n c o m e d o n o t l e a d t o s t r o n g e m o t i o n s o nt h e p a r t o f t h e i n t e r v i e w e e n o r t o p h y s i c a l h a r m t o t h e i n t e r v i e w e r .

A l t h o u g h t h e h a p p y e n d i n g o f t h is a d v e n t u r e m a y g iv e u s s o m e c o n f i d e n c ei n t h e p o s s i b i l i t y o f d i r e c t u t i l i t y m e a s u r e m e n t , i t i s n o t t h e o n l y p i e c e o fe v i d e n c e . F o r e x a m p l e , i t a p p e a r s t o b e p o s s i b l e t o d i s c r i m i n a t e b e t w e e np o s s i b le f o r m s o f u t il it y f u n c t i o n s . I n o t h e r w o r d s , f o r t h e r e s p o n d e n t s i ns u r v e y s i n w h i c h d i r e c t u ti li ty m e a s u r e m e n t w a s u n d e r t a k e n , t h e t h r e e e x a m -p l e s d r a w n i n F i g . 1 a r e d e f i n i t e l y n o t e q u iv a le n t (s ee V a n H e r w a a r d e n a n dK a p t e y n , 1 9 8 1 ) .

4 IND IRECT M EASUREMEN T OF UTILITY FUNCTIONSI n t h e r e m a i n d e r o f t h e p a p e r , I w i ll c o n s i d e r th e q u e s t i o n o f t o w h a t e x t e n td i r e c t m e a s u r e m e n t o f u t il i ty f u n c t i o n s c a n h e lp t o s o lv e s o m e t h e o r e t i c a l a n dp r a c t i c a l p r o b l e m s i n e c o n o m i c s . T o t h i s e n d w e f i r s t h a v e t o g i v e s o m et h o u g h t t o t h e r o l e o f u t il it y f u n c t i o n s in e m p i r i c a l e c o n o m i c m o d e l s .

I n e c o n o m i c m o d e l s o f b e h a v i o u r , i t is i n v a r ia b l y a s s u m e d t h a t a n i n d i v id u a lb e h a v e s i n s u c h a w a y t h a t h i s u ti li ty is m a x i m i z e d . I n h i s a t t e m p t s t o m a x i m i z eu t il it y , h e i s h a m p e r e d b y o n e o r m o r e c o n s tr a in t s. T h e s t a n d a r d e x a m p l e o ft h is k i n d o f m o d e l l i n g iS t h e n e o c l a ss i ca l m o d e l o f c o n s u m p t i o n b e h a v i o u rw h e r e t h e c o n s u m e r f a c es th e t a s k o f s p e n d i n g hi s i n c o m e o n c o n s u m p t i o ng o o d s s o a s t o m a x i m i z e h i s u t i l i t y . U n d e r r a t h e r w e a k a s s u m p t i o n s , t h ec o n s u m e r ' s p u r c h a s e s a r e u n i q u e l y d e t e r m i n e d b y h is in c o m e a n d t h e p r ic e s h eh a s t o p a y ( t o g e t h e r c o n s t i tu t i n g t h e b u d g e t c o n s t r a in t s ) a n d t h e f o r m o f h isu t i l i ty f u n c t i o n ( r e p r e s e n t i n g h i s p r e f e r e n c e s ) . A s s a id e a r l i e r , i t s u f f ic e s t h a tt h e u t i li t y f u n c t i o n i s m e a s u r a b l e o n a n o r d i n a l s c a le .

T h u s , i n e c o n o m i c m o d e l s a n i n d i v i d u a l ' s b e h a v i o u r i s c o m p l e t e l y d e t e r -m i n e d b y t w o t h i n g s : h i s p r e f e r e n c e s - r e p r e s e n t e d b y a n o r d i n a l u t i l i t yf u n c t i o n - a n d t h e c o n s t r a in t s th a t l i m i t h is b e h a v i o u r . I f a r e s e a r c h e r k n o w st h e s e c o n s t r a i n t s , h e c a n e m p l o y o b s e r v a t i o n s o n t h e i n d i v i d u a l 's b e h a v i o u r t od r a w c o n c l u s i o n s a b o u t t h e i n d i v i d u a l 's p r e f e r e n c e s .

T h i s is th e s o - c a ll e d r e v e a l e d p r e f e r e n c e a p p r o a c h b u t I w ill u s u a l l y d e n o t e i ta s i n d i r e c t u t i l i t y m e a s u r e m e n t , i n c o n t ra s t w i t h d ir e c t u t il i ty m e a s u r e m e n t , a si n t r o d u c e d a b o v e . T h e a d v a n t a g e o f i n d i r e c t u t il it y m e a s u r e m e n t is t h a t , i ng e n e r a l , o n e c a n d o w i t h o u t th e a s s u m p t i o n o f c a r d i n a l m e a s u r a b i l it y . I n v o k -i n g O c k h a m ' s r a z o r 6 t hi s a s s u m p t i o n h a s t h e r e f o r e b e e n r e m o v e d f r o m e c o -n o m i c t h e o r y .T h e r e m o v a l o f t h e c a r d i n a l it y a s s u m p t i o n s is n o t w i t h o u t c o s t, h o w e v e r .6 "What an be done with fewer(assumptions) s don e n vainwith mo re. ' Ascribed o W illiamofOckh am (c a. 1285-1349). See E dw ard s (1967, p. 307).


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6 A. KAPTEY NT h e p r i c e t h a t h a s t o b e p a i d c o n si st s o f a s iz e a bl e n u m b e r o f o t h e r a s s u m p -t io n s . T o m a k e t h a t c l e a r , le t u s o n c e a g ai n c o n s i d e r t h e e c o n o m i c t h e o r y o fc o n s u m e r b e h a v i o u r . T o o b t a i n r e a so n a b l y a c cu r a te k n o w l e d g e a b o u t t h eu t il it y f u n c t i o n o f a c o n s u m e r , w e n e e d a r a t h e r l a r g e n u m b e r o f o b s e r v a t i o n so n h i s b e h a v i o u r in d i f f e r e n t s i t u a ti o n s . S p e c i f ic a l ly , w e h a v e t o o b s e r v e t h ec o n s u m p t i o n b u n d l e h e c h o o s e s a t d i f f e r e n t c o m b i n a t i o n s o f p r ic e s a n d in -C o m e . H o w e v e r , w e c a n n o t v a r y p r ic e s a n d i n c o m e a t w i ll. 7 H e n c e a d i f f e re n ta p p r o a c h is a d o p t e d . T h e u t i li ty f u n c t i o n is a s s u m e d t o h a v e s o m e , a p r i o r is p e c i fi e d , p la u s i b le f u n c t i o n a l f o r m w i t h s o m e u n k n o w n p a r a m e t e r s w h o s ev a lu e s h a v e t o b e d e t e r m i n e d .

B y a n d l a r g e , d i f f e r e n t f a m i l ie s , o r g r o u p s o f f a m i l i es , a r e a s s u m e d t o h a v ei d e n t i c a l u t i li t y f u n c t i o n s . B y o b s e r v i n g f a m i l i e s, o r g r o u p s o f t h e m , f o r a ne x t e n d e d p e r i o d o f ti m e , s u f fi c ie n t v a ri a t io n i n p r i ce s a n d i n c o m e w i ll o c c u r s ot h a t o n e is a b l e t o e s t i m a t e t h e u n k n o w n p a r a m e t e r s . O n c e t h e d e m a n d s y s t e ma n d h e n c e t h e u t i l it y f u n c t i o n h as b e e n e s t i m a t e d , f u t u r e b e h a v i o u r c an b ep r e d i c t e d .

W h a t a r e , i n v i e w o f t h is p r o c e d u r e , t h e a d d i t i o n a l a ss u m p t i o n s t h a t a r er e q u i r e d t o m e a s u r e u t il it y f u n c t io n s i n d i r e c tl y ? T h e y i n c lu d e t h e f o ll o w in g :- T h e a p r i o r i s p e c i f i e d f u n c t i o n a l f o r m i s c o r r e c t .- T h e u t i l it y f u n c t i o n s o f d i f f e r e n t fa m i l i e s a r e i n d e e d i d e n t i c a l a n d t h e y d o

n o t s h if t o v e r t im e .- O b s e r v e d b e h a v i o u r o f f a m i li e s d o e s i n d e e d s t e m f r o m t h e m a x i m i z a t i o n o fa u t i li t y f u n c t i o n s u b j e c t t o c o n s t r a i n t s .- T h e u t i li ty o f f a m i li e s is n o t d e p e n d e n t u p o n t h e b e h a v i o u r o f o t h e r fa m -

i l ie s .- F a m i l i e s h a v e a t t h e i r d is p o s a l a ll r e l e v a n t i n f o r m a t i o n r e q u i r e d f o r a n

o p t i m a l d e c i s i o n . T h e i n f o r m a t i o n is c e r ta i n .T h i s l is t o f a s s u m p t i o n s is ea s il y e x t e n d e d . F o r e x a m p l e , i n m a n y e m p i r ic a l

s t u d ie s a g g r e g a t i o n r e q u i r e s a d d i ti o n a l a ss u m p t i o n s . O n t h e o t h e r h a n d , s o m eo f t h e s e a s s u m p t i o n s h a v e b e e n r e l a x e d i n c e r ta i n s t u d ie s . 8 H o w e v e r t h is m a yb e , i t is a fa i r ly l o n g l is t a n d e a c h o f t h e a s s u m p t i o n s i s q u e s t i o n a b l e .T h e m o s t p r o b l e m a t i c a s p e c t o f t hi s li st o f a s s u m p t i o n s is n o t i ts l e n g t h , b u tt h e v i r t u a l i m p o s s i b il i ty t o t e s t a s su m p t i o n s s e p a r a te l y . B y w a y o f e x a m p l e ,i m a g i n e t h a t i n t h e w a y d e s c r i b e d a b o v e w e h a v e e s t i m a t e d ' t h e ' u t i l i t yf u n c t i o n o f 't h e ' ( r e p r e s e n t a t i v e ) h o u s e h o l d in t h e N e t h e r l a n d s a n d t h e c o r r e -s p o n d i n g d e m a n d f u n c ti o n s f o r c o n s u m p t i o n g o o d s. F u r t h e r m o r e , i m a g i n et h a t w e u s e t h e r e su l ts t o p r e d i c t a g g r e g a t e p r i v a t e c o n s u m p t i o n in t h e f u t u r e .7 Ex cep tion s are to som e extent prisons, psychiatric wards and animal laboratories whereexperiments are carried out occasionally.See . for instance, Battalio et al. (1973), Battalio, K agel,Rey nold s (1978), Lea (1982).8 See, for instanc e, Phlips (1972, 1974), M anser (1976) and P ollak (1978), and the referencestherein for m odels wh ere changing preferenc es are allowe d. In M uellbauer (1977, 1980) one findsman y references .to models where utility functions depend on familycomposition.


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UTILITY AND ECONOMICS 7F i n a l ly , s u p p o s e t h e p r e d i c t io n s a r e i n f e r i o r 2 W h a t s h o u l d w e c o n c l u d e t h e n ?W e r e w e m i s t a k e n in a s s u m i n g t h a t f a m i li es tr y t o m a x i m i z e u t il it y ? D od i f f e r e n t f a m i l i e s h a v e d i f f e r e n t u t i l i t y f u n c t i o n s ? D o u t i l i t y f u n c t i o n s s h i f to v e r t i m e ? D i d w e s p e c i fy an i n c o r r e c t f u n c ti o n a l f o r m ? D i d w e m a k e m i s t a k e si n t h e a g g r e g a t i o n o f fa m i l y d e m a n d f u n c t io n s to a g g r e g a t e d e m a n d f u n c t io n s ?A r e t h e r e i n f o r m a t i o n a l c o n s t r a i n t s t h a t p r e v e n t f a m i l i e s f r o m f i n d i n g ap o s i t i o n w i t h m a x i m u m u t i l i t y ? D i s e n t a n g l i n g t h e s e a n d o t h e r p o s s i b i l i t i e sp r e s e n t s a n a r d u o u s t a s k .

N o w a s s u m e t h a t w e a r e a b l e to m e a s u r e a c o n s u m e r ' s u ti li ty f u n c t i o nd i r e c t l y , t h a t i s , w i t h o u t r e s o r t t o o b s e r v a t i o n s a b o u t h i s b e h a v i o u r . S u c hm e a s u r e m e n t c o u l d b e t h e re s u lt o f e x t e n s iv e i n t er v i ew s , o r t h e o u t c o m e o fp s y c h o l o g i c a l e x p e r i m e n t s . i I n th i s c ase the a s sumpt ions c an be t e s t e d se par -a te ly . W e c a n f i r st i n v e s t ig a t e w h a t t h e f o r m o f t h e u t i li t y f u n c t i o n i s . N e x t , w ei n v e s t i g a t e w h e t h e r d i f f e r e n t c o n s u m e r s h a v e i d e n t i c a l u ti l it y f u n c t i o n s . I f n o t ,w e c a n t r y to f i n d o u t w h a t c a u s e s t h e d i f f e r e n c e s . I n t h e t h i r d p l a c e , t h em e a s u r e d u t il it y fu n c t i o n s c a n t h e n b e u s e d t o s e e i f c o n s u m e r s d o m a x i m i z eu t i li t y o r w h e t h e r t h e y f o l l o w d i f f e r e n t ru l e s o f b e h a v i o u r .

T h u s w e s e e t h a t i f i t is p o s s i b l e t o m e a s u r e u t i li ty d i re c t l y , i n d e p e n d e n t o fo b s e r v a t i o n s a b o u t b e h a v i o u r , r e s e a r c h i n to e c o n o m i c b e h a v i o u r c a n b e sp li tu p i n t o a n u m b e r o f e le m e n t s t h a t c a n b e i n v e s ti g a te d s e p a r a t e ly . T h i s m a k e sr e s e a r c h i n t o e c o n o m i c b e h a v i o u r s im p l e r , a l th o u g h n o t s i m p le .

T h e t h r e e e l e m e n t s d i s t in g u i sh e d h e r e , m e a s u r e m e n t o f u t il it y f u n c t io n s ,e x p l a n a t i o n o f d i f f e re n c e s b e t w e e n i n d iv i d ua l s, t e s ts o f b e h a v i o u r a l h y p o t h -e s e s , c o n s t i t u t e a r e s e a r c h p r o g r a m t o w h i c h I h a v e d e v o t e d a s u b s t a n t i a l p a r to f m y t i m e , i n c o l l a b o r a t io n w i t h o t h e rs . A m a j o r p a r t o f t h is w o r k h a s b e e nd o n e a s p a r t o f t h e s o - c al le d L e y d e n I n c o m e E v a l u a t i o n P r o j e c t .

I t i s w o r t h n o t i n g t h a t t h e r e s e a r c h p r o g r a m o u t l i n e d h e r e f i t s i n w i t h t h ep r e d o m i n a n t p a r a d i g m i n e c o n o m i c s . B u t t h e d i r ec t m e a s u r e m e n t o f u t il it yf u n c t i o n s l e a d s t o a r e s e a r c h p r a c t i c e t h a t i s q u i t e d i f f e r e n t f r o m e x i st i n gp r a c t i c e . I n t h e r e m a i n d e r o f t h e p a p e r , t h is w il l b e i l lu s t r a t e d b y m e a n s o f t h es e c o n d p a r t o f t h e r e s e a r c h p r o g r a m : t h e e x p l a n a t i o n o f d if f e re n c e s in u t il it yf u n c ti o n s a m o n g c o n s u m e r s.

5 PREFERENCE FORMATIONI w i ll d e n o t e t h e o r i e s d e a l i n g w i t h t h e e x p l a n a t i o n o f d i f f e r e n c e s i n u t il i tyf u n c t i o n s a m o n g i n d i v i d u a ls , o r fa m i l i e s, a s t h e o r i e s o f p r e f e r e n c e f o r m a -

9 A rather p lausible assump tion, considering experiences wi th the p rediction of agg regateconsump tion in the Netherlands over the past twenty years. See Van der Leeuw (1984).10 As experiments dealing with decisions under un certainty. See Grether (1978) or S choemak er(1982) for rev iews.


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8 A. KAPTEYNt i o n . n I t is c u s t o m a r y t o d i s ti n g u i sh t w o a s p e c t s t o p r e f e r e n c e f o r m a t i o n , v i z .h a b i t f o r m a t i o n a n d p r e f e r e n c e i n t e r d e p e n d e n c e . H a b i t f o r m a t i o n i s t h ep h e n o m e n o n b y w h i c h m y b e h a v i o u r in th e p a s t ( o r r e s u l ts o f t h a t b e h a v i o u r )i n f lu e n c e s m y p r e s e n t p r e f e r e n c e s . P r e f e r e n c e i n t e r d e p e n d e n c e d e n o t e s t h ep h e n o m e n o n b y w hic h b e h av i ou r o f o ther s i n f l u e n c e s m y p r e f e r e n c e s . I n t h ef ir s t i n s t a n c e , I l i k e t o h a v e a h o u s e w i th a g a r d e n b e c a u s e I a m u s e d t o h a v i n go n e . I n t h e s e c o n d i n s t a n c e , I li k e t o h a v e a h o u s e w i t h a g a r d e n b e c a u s e m o s to f m y f r i e n d s h a v e o n e .

T o i n c o r p o r a t e p r e f e r e n c e f o r m a t i o n in t o d e m a n d s y s te m s c r e a te s a n u m b e ro f t h o r n y p r o b l e m s . A s o b s e r v e d b y D u e s e n b e r r y (1 94 9, p. 1 7): 'O r d i n a r i l y w et ry to m e a s u r e p r e f e r e n c e p a r a m e t e r s ( o r f u n c t io n s o f t h e m ) b y m a r k e tb e h a v i o r , s i n c e w e c a n n o t o b s e r v e t h e p r e f e r e n c e s d i r e c t l y . W i t h s h i f t i n gp a r a m e t e r s w e s h o u l d b e c a r r y in g i n d ir e c t m e a s u r e m e n t a s te p f u r th e r . W ew o u l d n o t o n l y h a v e t o m e a s u r e t h e p r e f e r e n c e p a r a m e t e r s b u t t h e p a r a m e t e r so f th e r e l a t i o n g o v e r n i n g s h i ft s i n t h e p r e f e r e n c e . ' T o f i n d t h e c o r r e c t s p e c i fi c a -t io n s t o d e s c r i b e t h e s e s h if ts t h e n b e c o m e s a r i sk y e n t e r p r i s e , e s p e c i a l ly s in c ew e d o n o t k n o w t h e c o r r e c t f o r m o f t h e u t i li ty f u n c t i o n n o r t h e c o r r e c tb e h a v i o u r a l r u le ( u ti li ty m a x i m i z a t io n o r s o m e t h i n g e l se ) , etc. A s a r e s u l t ,m o s t e c o n o m i s ts h a v e a b s t a i n e d f r o m i n c o r p o r a t i n g p r e f e r e n c e f o r m a t i o n in t om o d e l s o f d e m a n d . H a b i t f o r m a t i o n is e n c o u n t e r e d o c c a s io n a l ly in e m p i r ic a lw o r k . 12 E m p i r i c a l s t u d ie s o f p r e f e r e n c e i n t e r d e p e n d e n c e i n d e m a n d s y s te m sa r e a t p r e s e n t v i r t u a l ly n o n e x is t e n t5 3S o m e e c o n o m i s t s si m p l y d e n y t h a t p r e f e re n c e s m a y c h a n g e , e.g. S t i g le r a n dB e c k e r (1 97 7, p . 7 6 ) w h o s t a te t h a t ' . . . t a s te s ( d o ) n e i t h e r c h a n g e c a p r i c i o u s lyn o r d i f fe r i m p o r t a n t l y b e t w e e n p e o p l e . . , o n e d o e s n o t a rg u e o v e r t as te s fo rt h e s a m e r e a s o n t h a t o n e d o e s n o t a r g u e o v e r t he R o c k y M o u n t a i n s - b o t h a r et h e r e , w i ll b e t h e r e n e x t y e a r , t o o , a n d a r e t h e s a m e t o a l l m e n . ' I n t h e i r p a p e r ,t h e y e x p l a i n a n u m b e r o f i n s ta n c e s o f a p p a r e n t s h if ts in p r e f e r e n c e , e.g.a d d i c t i o n , a d v e r t i s i n g a n d f a s h i o n , b y a s s u m i n g t h a t i n a ll t h e s e c a s es i t is a ni n d i v i d u a l ' s e f f ic i e n c y a s a p r o d u c e r o f p l e a s u r e t h a t c h a n g e s , b u t n o t h i sp r e f e r e n c e s . I t is h a r d t o im a g i n e t h a t t h e i r p a p e r w o u l d h a v e b e e n w r i t te n h a dt h e a u t h o r s h a d a v a i l a b le d i r e c t ly m e a s u r e d u t il it y f u n c t i o n s a n d h a d t h e s eu t i li t y f u n c t i o n s b e e n d i f f e r e n t fo r d i f f e r e n t in d i v i d u a ls .

I n s u m , i n d ir e c t ( r e v e a l e d p r e f e r e n c e ) m e a s u r e m e n t o f ut il it y f u n c t io n sm a k e s it h a r d e r t o m o d e l p r e f e r e n c e f o r m a t i o n a d e q u a t e l y . O n t h e o t h e r h a n dt h is m a k e s i t e a s i e r t o m a i n t a i n t h a t p r e f e r e n c e s a r e c o n s t a n t a n d t h e s a m e f o re v e r y o n e , i rr e s p e c t i v e o f e m p i r ic a l e v id e n c e .

11 For, utility functions repre sent preference s. So, if preferences differ, utility functionsdiffer,and vice versa.12 E. g . , H outha kke r and Ta ylor (1970), Philips (1972, 1974), M anse r (1976), D arrou gh, Po llakand W ales (1983).13 An exception s Kapteyn, Van de G ee r, Van de Stadt, W ansbeek (1984).


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UTILITY AND ECONOMICS 96 ARE PREFERENCES CONSTANT AND TH E SAME FOR EVERYONE?T o a n s w e r t h i s q u e s t i o n , l e t u s c o n s i d e r s o m e e x a m p l e s . T h e f ir st e x a m p l e i sf r o m D u n c a n (1 97 5). I n t w o s u r v ey s o f h o u s e w i v e s in t h e G r e a t e r D e t r o i t a r e a ,h e l d i n 19 55 a n d 1 97 1, t h e r e s p o n d e n t s w e r e a s k e d t o e x p r e s s t h e i r s a t is f a c ti o no r d i s s a t is f a c ti o n w i t h t h e i r s t a n d a r d o f l iv in g . A l t h o u g h r e a l m e d i a n i n c o m e int h e 1 9 7 1 s u r v e y w a s 4 2 % h i g h e r t h a n i n t h e 1 95 5 s u r v e y , t h e d i s t r i b u t io n o fr e s p o n s e s i n b o t h y e a r s w a s v i r t u a ll y t h e s a m e . W i t h i n e a c h su r v e y , h o w e v e r ,s a t i s fa c t i o n w i t h o n e ' s s t a n d a r d o f li v in g c o r r e l a t e s s i g n if i ca n t ly , a n d p o s i -t i v e l y , w i t h i n c o m e .

C a n w e r e c o n c i l e th e s e o u t c o m e s w i t h c o n s t a n t a n d i d e n t ic a l p r e f e r e n c e s ? I fp r e f e r e n c e s a r e c o n s t a n t a n d t h e s a m e f o r e v e r y o n e , o n e w o u l d e x p e c t t h a tp e o p l e w i t h a h i g h e r i n c o m e a r e m o r e s a t i s fi e d w i t h it t h a n p e o p l e w i th a l o w e ri n c o m e . T h i s e x p e c t a t i o n i s c o n f i r m e d i n b o t h y e a r s . B u t o n e w o u l d a l s oe x p e c t t h e 1 9 7 1 r e s p o n d e n t s t o b e m o r e s a t i s fi e d , o n a v e r a g e , t h a n t h e 1 95 5r e s p o n d e n t s . T h i s e x p e c t a t i o n is n o t c o n f i r m e d a t a ll . D u n c a n ' s f i n d in g s c a n b ee x p l a i n e d b e t t e r b y th e h y p o t h e s i s t h a t p r e f e r e n c e s a re r e l a t i v e . T h a t is , p e o p l ee v a l u a t e t h e i r i n c o m e o r s t a n d a r d o f l iv in g b y c o m p a r i n g i t t o t h e i n c o m e o rs t a n d a r d o f li v in g o f o t h e r s .

T h e i d e a t h a t p r e f e r e n c e s a r e r e l a t iv e is al so c o n f i r m e d b y a w e l l - k n o w ns t u d y o f E a s t e r l i n ( 1 97 4 ) , w h o u s e s s e l f - ra t i n g s o f h a p p i n e s s b y i n d i v i d u a l s inv a r i o u s c o u n t r i e s - r i ch a n d p o o r , e a s t e r n a n d w e s t e r n . W i t h i n e a c h c o u n t r y ,t h e h a p p i n e s s r a t in g s c o r r e l a t e d p o s i t i v e ly w i t h i n c o m e , b u t a c r o s s c o u n t r i e st h e r e is n o d i s c e rn i b l e r e la t io n s h i p b e t w e e n n a t i o n a l i n c o m e p e r c a p i t a a n d t h em e a n h a p p i n e s s r a ti n g o f a c o u n t r y .

A s o n e m i g h t e x p e c t , t h e r e l a ti v i t y o f p r e f e r e n c e s , o r e v a l u a t i o n s , i s n o tr e s t r i c t e d t o t h e i n c o m e d o m a i n . F o r i n s t a n c e , D a v i s ( 1 9 6 6 ) f i n d s t h a t s e l f -c o n f i d e n c e o f A m e r i c a n s t u d e n t s - a n d e s p e c ia l ly t h e i r c a r e e r p la n s - d e p e n dh e a v i l y o n t h e i r p e r f o r m a n c e r e la t iv e t o t h e i r f el lo w s t u d e n ts . T h i s h a p p e n sd e s p i t e t h e f a c t t h a t in t h e A m e r i c a n s y s t e m t h e b e s t s t u d e n t a t o n e u n i v e r s i t ym i g h t v e r y w e l l h a v e b e e n t h e w o r s t s t u d e n t a t a n o t h e r u n i v e r s i ty . ~4

T h e n u m b e r o f t h e s e e x a m p l e s c a n b e in c r e a s e d a l m o s t a t w i ll . I n s o c i o l o g y ,R e l a t i v e D e p r i v a t i o n t h e o r y ( R D t h e o r y , fo r s h o r t) e x p la i ns p h e n o m e n a l i ket h e s e . ~5 T h e e x t e n t t o w h i c h a n i n d i v i d u a l i s r e l a t i v e l y d e p r i v e d w i t h r e s p e c t t oa c e r t a in d i m e n s i o n d e p e n d s o n w h o m h e c o m p a r e s h im s e l f w i t h an d w h e t h e rt h e s e o t h e r s a r e d o i n g b e t t e r o r w o r s e o n t hi s d im e n s i o n t h a n t h e i n d iv i d u a lh i m s e lf . S u p p o s e , t h e r e l e v a n t d i m e n s i o n f o r m e a t th is m o m e n t is 'p l a y in gc h e s s ' a n d I c o m p a r e m y o w n a b i l it ie s w i t h t h o s e o f th e f a c u l t y m e m b e r s a t t h ed e p a r t m e n t o f e c o n o m e t r i c s o f T i l b u r g U n i v e r s it y . A s f a r as c he s s a b il it y isc o n c e r n e d , I w ill b e r a t h e r d e p r i v e d . I f , i n s t e a d o f c o m p a r i n g m y s e l f w i t h m y14 See a lso Bassis (1971) for a related analysis and Ka pteyn and W ansb eek (1982) for aninterpretation.15 See, for instance, Stouffer et al. (1949), M erton and K itt (1950), Da vis (1959), Run ciman(1966).


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10 A . K A P T E Y Ncolleagues in the department, I compare myself with the other members of myfamily, my deprivation is really not so dramatic. However, this tends to take aturn for the worse, with my children getting older, and getting better at thegame.One is not necessarily deprived relative to others. One can also compare toone's own situation in the past. Comparison of my present chess playing abilityto my abilities in the past reinforces my deprivation with respect to thisdimension.

7 C A N E V A L U A T I O N S B E A B S O L U T E ?Before returning to the more restricted area of preference formation, let mebriefly discuss a related theory from experimental psychology. This so-calledAdaptation Level theory (AL theory, for short) has been developed by Helson(1964). The central notion in this theory - adaptation le ve l- is defined byHelson as follows ' . . . adaptation level is defined as a weighted geometricmean of all stimuli impinging upon the organism from without and all stimuliaffecting behavior from within.'16 Of course, this is a rather vague description,which has to be operational ized within a concrete context. Therefore, I brieflypresent some examples.The first example deals with an experiment carried out by Helson andKozaki . 17 Four groups of five experimental subjects were shown randompatterns of 10, 12, 14, 16 and 18 dots respectively. Each pattern was visibleduring 3/10ths of a second. Before this, one group was shown a random patternof 4 dots, the second one a pattern of 13 dots and the third group a pattern of 32dots. The fourth group (the control group) was not shown a dot pattern inadvance. During the experiment, the experimental subjects had to estimatehow many dots they were shown each time. It turned out that the first group,which had been shown 4 dots before the experiment, consistently gave thehighest estimates whereas the third group, which had been shown 32 dots inadvance, gave the lowest estimates. The remaining two groups gave estimatesin between. Here, the adaptation level is defined as a weighted geometricaverage of the random dot pattern shown to them before the experiment. Bythis definition, the first group has the lowest adaptation level, and henceprovides the highest estimates in the experiment. The third group has thehighest adaptation level and therefore gives the lowest estimate of the numberof dots shown to them.A somewhat related experiment is due to Ross and Thibaut (1974). Experi-mental subjects were shown 19 slides, each for one-fourth of a second. Theslides showed 16 x 16 matrices containing zeros and ones. The subjects weretold that each matrix represented the judgment of a jury of 16 laymen who hadevaluated paintings with respect to 16 different dimensions, like color, com-16 H els on (1964 , p . 59) .17 C f. H e l s o n a n d K o z a k i ( 19 68 ). T h e e x p e r i m e n t is a ls o d e s c r i b e d i n H e l s o n ( 19 71 ).


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U T I L I T Y A N D E C O N O M I C S 11

position, perspective, etc. A 'one' represents a good evaluation and a 'zero,'represents a bad evaluation. Thus, the more ones a slide shows, the better wasthe corresponding painting evaluated. For half of the subjects, the nineteenslides were presented in increasing order of the number of ones. For the otherhalf of the subjects, the presentat ion was in decreasing order of the number ofones. After that, both groups were shown one more slide with exactly as manyones as zeros. The subjects were asked to rate this last picture on a scale from 1(an extremely bad painting) to 20 (an outstanding painting). It turns out thatthe first group, which saw slides in order of an increasing number of ones, gavea significantly lower rating to this last painting than the second group.

The common elements of RD theory and AL theory are obvious. Evalua-tions, opinions and perceptions are nonconstant, but are formed under theinfluence of previous experiences. These previous experiences then serve as astandard of comparison. In view of the large variety of phenomena that iscovered by AL theory and RD theory, it would be quite a surprise if utilityfunctions were immutable. And indeed they are not! Approximately eightyears ago, I formulated a theory of preference formation which has majorcommunalities with AL and RD theory, albeit that at the time I had neverheard of AL theory. 18

8 A T H E O R Y O F P R E F E R E N C E F O R M A T I O NI will briefly sketch the basic features of my theory and then pay someatten tion to empirical evidence.The central notion of the theory is the so-called p e r c e i v e d d i s t r i b u t i o n . Letus, for didactic reasons, only consider preferences with respect to consumergoods and, moreover, restrict our attention to just one good. If we let 'income'be this one good, then the perceived distribution is a perceived incomedistribution. I will try to clarify this concept by means of a series of graphs.The solid line in Fig. 2 represents, for some hypothetical society, the incomedistribution. That is, for an arbitrary income measured along the horizontalaxis ( e . g . the point y) the corresponding point at the vertical axis (point A)indicates which proport ion of the population has an income less than or equalto this income.

This income distribution may be observable for the Central Bureau ofStatistics, but for individuals in society the distribution is rather irrelevant, asthey do not observe all other individuals and their incomes. An individualobserves only a subset of the population, and this subset is not chosen ran-domly. The dashed line in Fig. 2 represents the income distribution that isperceived by someone who knows mainly people with low incomes. For easeof language, I shall say that this individual has a 'poor reference group.' The1 8 S e e K a p t e y n ( 19 7 7) . I g o t a c q u a i n t e d w i t h A L t h e o r y t h r o u g h d i s c u s s i o n s w i t h R i c h a r dE a s t e r l i n . H a n s W e r n e r h a s b e e n s o k i n d a s t o p ro v i d e m e w i t h a n u m b e r o f r e c e n t r e f e r e n c e s tot h e l i t e r a t u r e .


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12 A. KAPT EYN

c u r e .r e l ,f r e q ,

l -B "

A -

C -

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p o o r r e f e re n c e g r o u pa f f l u e n t r e f e r e n c e g r o u pa c t u a l d i s t r i b u t i o n

f. . . . . . . . . . . . . . . . . . . . . ~s f ~ ' "

/ i 7 "/ ! . l " J. . . . . . . . . . . . . . . . . . y . . z/ ~ j . J "/ ~, i " . J ". . . . . . - z . . . . . . . . . . . - ~ - . - ,

y i n c o m e

F i g u r e 2 - A c t u a l a n d p e r c e i v e d i n c o m e d i s t r i b u t i o n i n a h y p o t h e t i c a l s o c i e t y

p r o p o r t i o n o f p e o p l e i n h i s r e f e r en c e g r o u p w i t h a n i n c o m e l es s t h an o r e q u a lt o y i s e q u a l t o O B . L e t u s , f i n a l ly , c o n s i d e r t h e t h i r d c u r v e i n F i g . 2 , w h i c h i sl o c a t e d t o t h e r i gh t . T h i s i s t h e p e r c e i v e d i n c o m e d i s t r i b u ti o n o f s o m e o n e w i t ha n a f f l u e n t r e f e r e n c e g r o u p . I n t h is r e f e r e n c e g r o u p o n l y a p r o p o r t i o n O C o fa ll p e o p l e h a v e a n i n c o m e l e ss t h a n o r e q u a l t o y .

A s s u m i n g t h a t t h e n o t i o n o f a ' p e r c e i v e d d i s tr i b u t io n ' is m o r e o r l e ss c le a r , Iw i l l n e x t c o m p l i c a t e t h i s n o t i o n a l i t t l e b i t . F i r s t o f a l l , t h e d e f i n i t i o n w i l l b eb r o a d e n e d t o a ls o i n c o r p o r a t e a n i n d i vi d u a l 's o w n i n c o m e . I n t h e p e r c e p t i o no f i n c o m e s , o n e ' s o w n i n c o m e p l a y s a r o l e , a n d p r o b a b l y an im p o r t a n t o n e . I nt h e s e c o n d p l a c e , I w a n t t h e d e f i n i t io n o f a p e r c e i v e d d i s tr i b u t io n to e n c o m -p a s s dynamica s p e c t s . F i g . 3 il l u s tr a t e s w h a t ! m e a n b y t h a t .

/ // /

j f "/ / . -/ / / I / Z f f "

/ / " ~ '* i n c o m e ,0

l a s t y e a rt h i s y e a ro v e r a l l

F i g u r e 3 - T h e o v e r a l l p e r c e i v e d i n c o m e d i s t ri b u t io n a s a c o n v e x c o m b i n a t i o n o f c o n t e m p o r a n e o u sp e r c e i v e d d i s t r i b u t i o n s

c u r e . r e l .f r e q .


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UTILITY AND ECONOMICS 13

I n F i g . 3 w e c o n s i d e r a n i n d i v i d u a l w h o h a s , d u r i n g h i s l if e , p e r c e i v e d t w oi n c o m e d i s t r i b u t i o n s , v i z . o n e d u r i n g l as t y e a r ( t h e c u r v e l o c a t e d t o t h e l e f t)a n d o n e d u r i n g th i s y e a r ( t h e c u r v e l o c a t e d t o t h e r i g h t ) . I ca l l t h e s e d i s t r ib u -t i o n s c o n t e m p o r a n e o u s d i s t r i b u t i o n s i n t h e t w o s e p a r a t e y e a r s . I d e f i n e t h eo v e r a l l p e r c e i v e d d i s t r i b u t i o n ( t o d a y ) a s a c o n v e x c o m b i n a t i o n o f t h e t w oc o n t e m p o r a n e o u s d i st ri b u ti o n s. T h e w e i g h ts in t h e c o n v e x c o m b i n a t i o n r e p r e -s e n t t h e r e l a t iv e i m p o r t a n c e o f t h e t w o y e a r s in th e f o r m a t i o n o f t h e o v e r a l lp e r c e p t i o n . T h e m a g n i t u d e o f t h e w e i g h ts is a n e m p i r i c a l m a t t e r . I t is a s s u m e di n F ig . 3 t h a t t h e i n d i v i d u a l u n d e r c o n s i d e r a t i o n g i v e s a h i g h e r w e i g h t to t h i sy e a r t h a n t o t h e p r e v i o u s y e a r . T h i s a p p e a r s t o b e a r e a s o n a b l e a s s u m p t i o n , a so n e w i ll h a v e s o m e w h a t l e ss v iv id m e m o r i e s o f t h e p r e v i o u s y e a r .

O f c o u r s e , m o s t p e o p l e l iv e l o n g e r t h a n t w o y e a r s , b u t t h e p r i n c ip l e r e m a i n st h e s a m e . I n s u b s e q u e n t p e r i o d s a n i n d iv i d u a l p e r c e i v e s v a r i o u s c o n t e m p o r -a n e o u s i n c o m e d i s t r ib u t i o n s a n d t o d a y ' s o v e r a l l p e r c e p t i o n i s a c o n v e x c o m -b i n a t i o n o f a l l c o n t e m p o r a n e o u s d i s t r i b u t i o n s . T h i s i s i l l u s t r a t e d i n a s l i g h t l yd i f f e r e n t fa s h i o n i n F ig . 4 . T h e c u r v e l o c a t e d m o s t t o t h e l e f t n o w p r e s e n t s t h eo v e r a l l p e r c e i v e d i n c o m e d i s t r i b u t i o n i n t h e p r e v i o u s y e a r , i . e . , a c o n v e xc o m b i n a t i o n o f a ll c o n t e m p o r a n e o u s i n c o m e d i s tr ib u t io n s p e r c e iv e d b y t h ei n d i v i d u a l u p t o a n d i n c l u d i n g la s t y e a r . T h e r i g h t h a n d c u r v e r e p r e s e n t s t h isy e a r ' s c o n t e m p o r a n e o u s p e r c e i v e d i n c o m e d i s t r i b u t i o n . T h e s o l i d l i n e i s t o -d a y ' s o v e r a l l p e r c e i v e d i n c o m e d i s tr i b u ti o n . I t is , i n t u r n , a c o n v e x c o m b i n a -t i o n o f t h e t w o o t h e r c u r v e s . N o t i c e t h a t t h e s o l i d l i n e is c l o s e r t o t h e l e f t - h a n dc u r v e t h a n t o t h e r i g h t - h a n d o n e . T h i s r e f l e c t s t h e p r e s u m p t i o n t h a t a l lp r e v i o u s y e a r s c o m b i n e d r e c e i v e a g r e a t e r w e i g h t t h a n t h is y e a r ' s c o n t e m p o -r a n o u s d i s t r i b u t i o n . W h e t h e r o r n o t t h i s p r e s u m p t i o n h o l d s t r u e c a n b ev e r i f i e d e m p i r i c a l ly .

T o k e e p m y s t o r y r e a s o n a b l y s im p l e , ] w ill n o t c o n s i d e r f u r t h e r c o m p l ic a -t i o n s , s u c h a s t h e f a c t t h a t d i s tr i b u t io n s o f i n c o m e u s u a l l y r e f e r t o f a m i l i e s

c u m . r e lf r e q

1

/ / J"/f ,/~ ~ , i,-/'~/7"/ 7.7// /"

income0overall Last year

. . . . . . . . . c o n te m p o r a n e o u s th i s yearoveral l this year

Figure 4 - The overall perceived income distr ibution this year as a conve com Nna tio n of theoverall perceived distribution of last year and the contemporaneous distribution of this year


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14 A. KAPTEYNrather than individuals. Nor will I consider an extension of the notion of aperceived distribution to more dimensions, although that would not create anynew conceptual problem. Furthermore, I will refer to 'overall perceiveddistributions' as 'perceived distributions' for short.Thus, for didactic reasons, I restrict myself to the distribution of incomes.My theory of preference formation now states that someone's evaluation ofsome income y on a zero-one scale is equal to the value of the perceiveddis tr ibu tion func t ion corresponding to tha t incom e y . For example: if accordingto my perceived distribution function 70% of all incomes are below 60,000.00guilders, then I evaluate an income equal to 60,000.00 guilders by 0.7. If 40%of the incomes are lower than 35,000.00 guilders, then ! evaluate an income of35,000.00 guilders by 0.4, etc.

Let us now return to the Detroit housewives. Despite an average realincrease of their incomes by 42%, their average satisfaction with their stan-dard of living had not increased, although within each survey satisfactionincreased significantly with income. These outcomes would have been pre-dicted by my theory. For, the incomes have increased by 42% but the distribu-tion has probably not changed very much and presumably the perceiveddistributions have not changed either.

Easterlin's findings also follow from the theory, provided at least that inperceived income distributions incomes in foreign countries play a negligiblerole. Under these circumstances per capita national income is basically irrele-vant for one 's satisfaction, but one 's position in the income distribution doesmatter.Recall, finally, the experimental subjects who were shown jury reports onpaintings. The subjects who were shown slides with an increasing number ofones end up having a perceived distribution which is located farther to the rightthan the subjects who were shown slides with a decreasing number of ones,provided that more recently shown slides have more influence on a perceiveddistribution than the earlier ones. If we then next show the subjects a slide with50% ones, this slide looks less favourable compared to the first distributionthan compared to the second distribution. This explains the differences inevaluation.It is not difficult to supplement this kind of qualitative evidence with newexamples. I prefer, however, to briefly sketch some quantitative results thatwere obtained recently (cf. Van de Stadt et al., 1985). The results are based onan analysis of the first two waves of the.so-called income evaluation panel ofthe Central Bureau of Statistics, which started in 1980. Evaluations of incomeare measured for each respondent in the panel by means of Van Praag'sincome evaluation question. The result of this measurement is known as therespondent's w elf ar e f unc t i on o f i ncom e (WFI). An individual's WFI describeshis evaluations of income levels on a zero-one scale. 19 It follows from my19 See Van Praag (1968) for its theoretical basis.


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theory of preference formation that an individual's measured WFI has to beidentical to his perceived income distribution. Using the information from thepanel, and with some econometric skill, one can quantify how for eachindividual in the panel the overall perceived income distribution has changedfrom 1980 to 1981.Fig. 5 illustrates some of the results. It shows for an arbitrarily selectedindividual in the panel the overall perceived income distribution in 1980, theoverall perceived income distribution in 1981 and the contemporaneous dis-tribution in 1981. The figure shows that the 1981-contemporaneous distr ibutionhas considerably less influence on the overall perceived distribution in 1981than the overall perceived distribution in 1980. To be a little more precise,according to our estimates the most recent contemporaneous distributionreceives a weight of approximately 20% and all preceding contemporaneousdistributions combined receive a weight equal to 80%.Since, according to the theory, the overall perceived distribution and theWFI are identical , one can also read Fig. 5 as follows. An individual's 1981 WFIis a convex combination of his 1980 WFI and the 1981-contemporaneousperceived distribution, where the most recent contemporaneous distributioncauses an 'innovat ion' of the WFI with 20%.

The contemporaneous perceived income distribution consists of two essen-tial elements: one's own income and the incomes of all others in the socialreference group. Our research indicates that one's own income gets a weightwhich is approximately two times higher than all other incomes combined. Itcan be shown that as a result an increase of one's own income by 10% has thesame beneficial effects on the satisfaction level as a decrease by 10% of theincomes of all others in the social reference group.

All evidence we have considered so far indicates that the preference forma-tion theory provides a good explanation of differences in the evaluation ofincome among individuals.1980 - W FI

te l . 1981 - W FI. . . . . . . 1 98 1 - contem poraneous d is tr ib ut io ncum,f r e q

/ f f f l ' 1 f/ J / ' J

/ /

i Ii i i / /~z z / / ' /

0 ~ 1 1 . I "~ ' " i n c o m eF i g u r e 5 - T h e 1 9 8 1 - W I a s a c o n v e x c o m b i n a t i o n o f t h e 1 9 8 1 - c o n t e m p o r a n e o u s d i s t r ib u t i o n a n dthe 1980-WFI


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16 A . K A P T E Y N9 S O M E C O N S E Q U E N C E S F O R E C O N O M I C S

Let me return to the theme I started out with. By using a directly measurablecardinal utility concept, Van Praag's WFI, it appears possible to quantify andtest a theory of preference formation. Although I have only mentionedinvestigations with respect to incomes, earlier work has shown that similaranalyses can be carried out with respect to somewhat narrower expenditurecategories ( c f . Kapteyn e t a l . , 1980). The aforementioned research with re-spect to RD and AL theory makes it clear, moroever, that the preferenceformation theory is part of a quite general mechanism that can also beobserved outside economics.What are the consequences of our results for economics? The answer is'none,' if we assume that the utility concepts we have used in the empiricaltests of the preference formation theory are not related at all to the indirectlymeasured utility concepts that underlie models of economic behaviour. It hasto be admitted that the utility functions that have been measured directlyhitherto are usually one-dimensional, or two-dimensional at most. 2 Further-more, there have been very few attempts to predict behavior on the basis ofthese directly measured utility functions. 2~ Thus, at the very least there is adifference in emphasis between our own research and research into neoclassi-cal models of behaviour. The main reason for this is that we want to learn moreabout utility functions before their impact on behaviour is investigated. In thelast instance, it is a mat ter of b e l i e f t o claim that models that deal with directlymeasured utility functions, e . g . my preference formation theory, are also validfor the indirectly measured utility functions that underlie models of behaviour.I find it hard to imagine, however, that verbal evaluations and indirectlyobserved preferences would be entirely unrelated. For example, when Iobserve that someone's opinion about the income he needs to maintain adecent standard of living depends heavily on the incomes in his social referencegroup, then I find it quite implausible that his preferences regarding how tospend his income are not related to the consumption pattern in his referencegroup.A related example deals wi th the measurement of the cost of living associ-ated with different family compositions. Both the direct and the indirectapproach aim at finding the compensating money amounts (family allow-ances) which would leave families that differ only with respect to their com-position equally well off. If the two approaches would yield different compen-sating amounts, it would imply that direct and indirect measurement of utilitygive different results. In that case I would not rest until an explanation for thediscrepancy was found. Hitherto, such a discrepancy has not occurred.2 0 A n e x a m p l e o f a d i r e c tl y m e a s u r e d t w o - d i m e n s i o n a l u t il it y f u n c t i o n c a n b e f o u n d in D a g e n a i s(1977).2 1 A n e x c e p t i o n i s K a p t e y n e t a l . (1979).


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T o r e p e a t , i t is u l t i m a t e l y a m a t t e r o f b e l i e f , b u t t h e b e l i e f is n o t u n f o u n d e d .S o l e t u s r e p e a t t h e q u e s t i o n o f w h a t c o n s e q u e n c e s o u r fi n d in g s h a v e f o re c o n o m i c s , n o w a s s u m i n g t h a t d i r e c t l y a n d i n d i r e c t l y m e a s u r e d u t i l i t y f u n c -t i o n s a r e c l o s e l y r e l a t e d c o n c e p t s . I w ill m e n t i o n a n u m b e r o f t h e m .I n t h e f i r st p l a c e , t h e p r e f e r e n c e f o r m a t i o n t h e o r y m a k e s i t c l e a r t h a t t h e r e isn o s u c h t h i n g a s a ' t ru e ' f u n c t io n a l f o r m o f t h e u t il it y f u n c t i o n . W h e n e v e rp e r c e i v e d d i s t r i b u t i o n f u n c t i o n s c h a n g e , u t i l i t y f u n c t i o n s c h a n g e w i t h t h e m .A t t e m p t s t o f in d t h e t r u e f o r m o f u t il it y f u n c t io n s , o r t o a p p r o x i m a t e t h e t r u ef o r m b y f l e x ib l e s p e c i f ic a t io n s ( c f . e . g . , Chr i s tensen , Jo rgenson , Lau , 1975 , o rJ o r g e n s o n a n d L a u , 1 9 7 9 ) b e c o m e f u t i l e . T h e r e i s n o t r u e f u n c t i o n a l f o r m .

A r e l a t e d , s o m e w h a t su r p ri si n g , c o n s e q u e n c e is t h a t t h e a t t e m p t to m e a s u r eu t i l ity func t ions d i r ec t ly th rea tens the cen t r a l ro le o f the u t i l i ty conc ep t ine c o n o m i c s . A l t h o u g h u t i l i t y f u n c t i o n s a r e u s e f u l m e a s u r a b l e r e p r e s e n t a t i o n so f p r e f e r e n c e s , t h e m o r e f u n d a m e n t a l c o n c e p t is t h e p e r c e i v e d d i s tr i b u t io nf u n c t i o n .

F r o m t h e v i e w p o i n t o f b u il d in g a n e f fi c ie n t r e s e a r c h s t r a te g y , i t se e m so b v i o u s t o m e t h a t d e m a n d s y s t e m s , c o n s u m p t i o n f u n c t i o n s , l a b o u r s u p p l yf u n c t i o n s , e t c . , a r e f u n d a m e n t a l l y m i s sp e c i f ie d if p r e f e r e n c e f o r m a t i o n is n o ta c c o u n t e d f o r . O f c o u r s e , m i s sp e c i f ie d m o d e l s d o n o t c o n t r i b u t e g r e a tl y t o t h eq u a l i t y o f e c o n o m e t r i c f o r e c a s t s .

F r o m a p o l ic y v i e w p o i n t , i t i s e q u a l l y im p o r t a n t t o t a k e p r e f e r e n c e f o r m a -t ion in to acco un t . I f , fo r in s tance , i t is inco r rec t ly as su m ed tha t u t i l i ty func t ionsa r e c o n s t a n t , a h ig h n a t i o n a l i n c o m e is t h e r e m e d y f o r a ll p r o b l e m s . I f w ea c c o u n t f o r t h e r e l a ti v e l y o f u t il it y , i t b e c o m e s c l e a r t h a t , f o r e x a m p l e , t h ee x t e n t o f p o v e r t y w i t h in a c o u n t r y i s n o t p r i m a r i ly a f u n c t io n o f t h e l e v e l o fn a t i o n a l i n c o m e , b u t r a t h e r o f i ts d i s t r i b u t i o n .

F o r t h o s e w h o h a v e a l w a y s c l a im e d t h a t i n c o m e s h a v e t o b e re d i s t r i b u t e d i na m o r e e q u i t a b l e w a y , t h e t h e o r y p r o v i d e s a w a r n i n g , h o w e v e r . I f t h e d i s tr i b u -t i o n o f i n c o m e s ( o r o f g o o d s , o r o f o t h e r s o u r c e s o f s a t is f a c ti o n ) b e c o m e s m o r ee q u a l , p e r c e i v e d d i s t r i b u t i o n s b e c o m e m o r e e q u a l a s w e l l . P u t d i f f e r e n t l y ,a l t h o u g h i n c o m e d i f f e r e n c e s m a y d e c r e a s e , t h e c o r r e s p o n d i n g c h a n g e i n p e r -c e i v e d d i s tr i b u t i o n s m a y i n d u c e a s tr o n g e r , r a t h e r t h a n a l e s se r , p e r c e p t i o n o ft h e s e d i f f e re n c e s . T h e p e r s i s t e n c e o f d is c u ss io n s a b o u t i n c o m e i n e q u a l i t y i nt h e N e t h e r l a n d s , d u r i n g a p e r i o d i n w h i c h t h e i n c o m e i n e q u a l i t y h a s d e -c r e a s e d , a p p e a r s t o c o n f i r m t h i s .

T h e r e l at i v e n a t u r e o f m y p r e f e re n c e f o r m a t i o n t h e o r y d o e s n o t i m p l y t h a te c o n o m i c g r o w t h, i . e . , an ac ro s s - the -bo ard r i s e o f incom es , i s i r r e levan t fo rs o m e o n e ' s e v a l u a t i o n o f h is s t a n d a r d o f liv in g. I n c o m e s f r o m t h e p a s t a r e p a r to f a p e r c e i v e d i n c o m e d i s t r ib u t i o n a n d i f t h e c u r r e n t i n c o m e e x c e e d s p a s ti n c o m e s , t h e c u r r e n t i n c o m e r a n k s h i g h ly in t h e p e r c e i v e d d i s t ri b u t io n . I t i s n o tt h e l e v e l o f i n c o m e t h a t c o u n t s , b u t it s g r o w t h .


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18 A . K A P T E Y N10 C O N C L U S I O NT h e c e n t r a l t h e m e o f t h is p a p e r h a s b e e n t h a t i f ' u ti l it y ' is t h e c e n t r a l c o n c e p t o fe c o n o m i c s , i t s h o u l d b e g i v e n t h e a t t e n t i o n i t d e s e r v e s . V a r i o u s e x a m p l e sind ica te the im po r tan ce o f do ing th is . Ignor ing p r~efe rence fo rma t ion l ead s toe c o n o m i c m o d e l s t h a t a r e m i s s pe c i fi e d . F o r p o li c y p u r p o s e s , t h e p r o b l e m o fu s i n g m i s s p e c i f ie d m o d e l s i s p e r h a p s o n l y m i n o r c o m p a r e d t o t h e f a c t t h a t i nt h e f o r m u l a t i o n o f p o l i c y g o a l s, p r e f e r e n c e f o r m a t i o n i s n e g l e c t e d a s w e l l, s ot h a t p o l i t ic a l g o a l s t u r n o u t t o b e s y s t e m a t i c a ll y u n a t t a i n a b l e . B y m e a n s o fi n a d e q u a t e t o o l s w e t r y t o r e a c h u n a t t a i n a b l e g o a l s .

T h e p a p e r i s a l s o a p l e a f o r i n t e rd i s c ip l i n a ry r e s e a r c h . H a d w e w a t c h e d t h eac t iv i t i e s o f ou r co l l ea gue s in the s i s t e r soc ia l s c iences a l i tt l e be t t e r , w e migh th a v e r e a l i z e d e a r l i e r t h a t u t i l i t y f u n c t i o n s c a n b e m e a s u r e d and t h a t t h e yc h a n g e a ll t h e ti m e . E c o n o m i c s m i g h t h a v e b e c o m e m o r e u s e f u l a s a r e su l t.

RE F E R E NC E S

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Ba t t a l i o , R .C . , E .B . F i s h e r , J .H . Ka g e l , R .L . Ba s s m a n , R .C . W in k l e r a n d L . Kr a s n e r , ' A T e s t o fCo n s u m e r De m a n d T h e o r y Us in g Ob s e r v a t i o n s o f I n d iv id u a l Co n s u m e r P u r c h a s e s , ' WesternEconomic Journal, XI (1973), pp. 411-425.

Ba t t a l i o , R .C . , J .H . Ka g e l a n d M .O . Re y n o ld s , ' A N o te o n th e D i s tr i b u t io n o f E a r n in g s a n dO u t p u t p e r H o u r i n a n E x p e r i m e n t a l E c o n o m y , ' Economic Journal, L XXXVI I I ( 1 9 7 8 ) , p p .822-829.

Be n th a m , J . , ' A n I n t r o d u c t i o n t o t h e P rin c ip l e s o f M o r a l s a n d L e g i s l a ti o n , ' Re p r in t e d i n : N .A .P a g e ( e d . ) , Utility TheOry. A Book of Readings, New York , 1823 .

Ch r i s t e n s e n , L .R . , D .W . J o r g e n s o n a n d L . J . L a u , ' T r a n s c e n d e n t a l L o g a r i th m ic U t i l it y F u n c -t i o n s , ' American Economic Review, LXV (1975), pp. 367-383.

Da g e n a i s , D .L . , ' E v a lu a t i n g P u b l i c Go o d s f r o m I n d iv id u a l W e l f a r e F u n c t i o n s , ' European Eco-nomic Review, IX (1977), pp. 123-149.Da r r o u g h , M . , R .A . P o l l a k a n d T . J . W a le s, ' Dy n a m ic a n d S to c h as t ic S tr u c tu r e : An A n a ly si s o fT h r e e T im e S e r i e s o f Ho u s e h o ld Bu d g e t S tu d i es , I Review of Economics and Statistics, L X V(1983), pp. 274-281.

Da v i s , J .A . , ' A F o r m a l I n t e r p r e t a t i o n o f t h e T h e o r y o f Re l a t i v e De p r iv a t i o n , ' Sociometry, X X I I(1959), pp. 280-296.Da v i s , J .A . , ' T h e C a m p u s a s a F r o g P o n d : A n Ap p l i c a t i o n o f t h e T h e o r y o f Re l a t i v e De p r iv a t i o nto Ca r e e r D e c i s io n s o f Co l l eg e M e n , ' American Journal of Sociology, LX X II (1966), pp. 17-31.

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1949.Du n c a n , O .D . , ' DOe s M o n e y Bu y S a ti s f a ct i o n ? ,' Social Indicators Research, II (1975), pp. 267-274.E a s t e rl i n, R . A . , ' D o e s E c o n o m i c G r o w t h I m p r o v e t he H u m a n L o t ? S o m e E m p i ri c al E v i d e n c e , 'i n : P .A . Da v id a n d M .W . Re d e r ( e d s . ) , Nations and Households in Economic Growth. Essaysin Honor of Moses Abramowitz, Ne w Y o r k , 1 97 4.


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U T I L I TY A N D E C O N O M I C S 19E d wa r d s , P . ( e d . ) , The Encylopaedia of Philosophy, Vol . 8 , London , 1967 .Gr e th e r , D .M . , ' Re c e n t P s y c h o lo g i c al S tu d ie s o f Be h a v io r u n d e r Un c e r t a in ty , ' American Eco-

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S u m m a r yU T I L IT Y A N D E C O N O M I C S

Al thou gh ' u t i l i ty ' has been the cen t ra l concep t in econom ics , economis ts have pa id re la t ive ly l i t t lea t ten t io n to i t s m easure me nt . Ge nera l ly , u t i l i ty i s mea sured ind i rec t ly v ia the revea led p re fe ren ceapproach . We d iscuss p rob lems wi th th i s approach and nex t in t roduce a l te rna t ive ' d i rec t ' mea-s u r e m e n t m e th o d s . T h e d i r e c t m e a s u r e m e n t m e th o d s a r e s e e n t o s pa wn a s o -c a ll e d t h e o r y o fp re fe renc e fo rm at ion , wh ich exp la ins d i f fe rences in u t i l ity func tions o f d i f fe ren t ind iv idua ls . Th es imi la r i t ie s o f th is the ory w i th re la ted theor ies in soc io logy and psycho logy , an d v a r ious so r t s o fempir ica l ev idence , a re rev iewed . The paper conc ludes wi th a d iscuss ion o f the impl ica t ions o fthese f ind ings fo r economic theor ies .

kapteyn arie - utility and economics

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