Maximization

CSGnet Archive CSG2007
1

[From Rick Marken (2007.11.07.1000)]

I was sent a paper recently on the Giffen effect. It's by two Harvard
economists who have actually collected data (in an experiment, yet!)
showing Giffen behavior (increased consumption of a good with increase
in the cost of that good) in a poor population in China. I haven't
finished the paper; it's quite long and quantitative (in that way
economists get quantitative, which is difficult for me to get my head
around). But it looks like a great paper and the authors clearly
understand that the Giffen effect is a control phenomenon, resulting
from the need to simultaneously control for consuming a reference
caloric input (what they call "subsistence") while at the same time
controlling expenditures so that don't exceed budget. Once I finish
the article I'll give a little report on what they did. But right now
I'm writing to get some discussion going on the concept of
maximization.

In the Giffen article the authors assume that people act to maximize
things like the amount of "fancy" food they consume. People want to
maximize their consumption of fancy food but those on limited budgets
(poor people) are limited in the amount of such food they can consume
because they have to consume the less preferred food in order to
maintain subsistence. This got me to thinking about maximization. I
can understand why maximization makes no sense in terms of perceptions
like "fancy food"; once you've consumed a certain (reference) amount
of Godiva chocolates, for example, more of that perception just hurts.
So there is clearly a reference for such perceptions. But there are
other perceptions -- like the perception of the size of the number
representing your bank balance -- that can get bigger and bigger and
never produce any pain. So maximization seems to be a reasonable
assumption with some variables, like money, but not others, like the
stuff money represents.

This is my observation. It think that, in an economic world where
there were no money, there would be no behavior that looks like
maximization. Instead, there would be obvious reference settings for
the amount of "stuff" people would want because people would know that
physical constraints (like spoilage) limit the amount of stuff you can
store. For example, you could only store a certain amount of mangos
before some rot. So your reference for mango consumption might be high
but it would not be infinitely high. Money, however, is just a
numerical symbol and there is no physical reason not to have that
number be as big as you can get it to be, ie. to maximize money. Since
economics is largely about money, it's no surprise, then, that
economists would conclude that maximizing (rather than controlling
relative to reference specifications) is what people do.

Whaddaya think?

Best

Rick

···

--
Richard S. Marken PhD
rsmarken@gmail.com

2

[From Fred Nickols (2007.11.07.1324 ET)]

Rick Marken (2007.11.07.1000)]

<snip>

This is my observation. It think that, in an economic world where
there were no money, there would be no behavior that looks like
maximization. Instead, there would be obvious reference settings for
the amount of "stuff" people would want because people would know that
physical constraints (like spoilage) limit the amount of stuff you can
store. For example, you could only store a certain amount of mangos
before some rot. So your reference for mango consumption might be high
but it would not be infinitely high. Money, however, is just a
numerical symbol and there is no physical reason not to have that
number be as big as you can get it to be, ie. to maximize money. Since
economics is largely about money, it's no surprise, then, that
economists would conclude that maximizing (rather than controlling
relative to reference specifications) is what people do.

Whaddaya think?

Kinda makes sense to me. Money, as a medium of exchange, has to provide "coverage" for all the many things for which it might be exchanged. Thus, my reference for food might be set in terms of some caloric figure. My reference for shelter might be set in terms of square feet, number of rooms or whatever. Similarly for other "things" and "stuff." The references for these things would indeed have some upper (and lower) limit. But, when it comes to money, it has to cover all those other "things" and "stuff" (e.g., rent or mortgage, grocery bill, gasoline, etc, etc). So, the upper limit of my reference for money overall would be higher than the reference (in money) for any one thing or piece of stuff). That said, I still have some kind of upper limit on my reference for money. This would be the zero error level (the figure at which my efforts to obtain money might fall off or cease). At some point, for me at least, enough is enough. There are, of course, other folks w!
ho meas
ure their worth or esteem or whatever in terms of money and they probably have no zero error level for money.

Anyway, I think money as a medium of exchange has to be equated to other things.

Thanks for the mental nudge...

Regards,

Fred Nickols
nickols@att.net

3

[From Richard Kennaway (2007.11.07.1925 GMT)]

[From Rick Marken (2007.11.07.1000)]
This is my observation. It think that, in an economic world where
there were no money, there would be no behavior that looks like
maximization. Instead, there would be obvious reference settings for
the amount of "stuff" people would want because people would know that
physical constraints (like spoilage) limit the amount of stuff you can
store. For example, you could only store a certain amount of mangos
before some rot. So your reference for mango consumption might be high
but it would not be infinitely high. Money, however, is just a
numerical symbol and there is no physical reason not to have that
number be as big as you can get it to be, ie. to maximize money. Since
economics is largely about money, it's no surprise, then, that
economists would conclude that maximizing (rather than controlling
relative to reference specifications) is what people do.

Whaddaya think?

I think that economics is not largely about money. It is about resources and the choices people make to obtain them. There may be many people in the world who have all the mangoes they would like. There are many who have all the food they would like. But who has all the resources they would like? Very few.

I think that in situations where one has a reference, but no possibility of achieving it, control behaviour is indistinguishable from maximising behaviour. Efforts are continually being made to get more of the perception, but they never stop because the reference is never reached. For example, the apparent desire of the subjects of the paper to maximise "fancy" food. If they have a reference quantity, it's one they don't have the means to reach.

I think that in an economic world in which there were no money, money would be invented. It was, after all. It is reinvented every time a community finds itself in a situation where there is a scarcity of conventional money: for example, LETS schemes, and the trading of cigarettes in prison (if they're still allowed to smoke there).

···

--
Richard Kennaway, jrk@cmp.uea.ac.uk, Richard Kennaway
School of Computing Sciences,
University of East Anglia, Norwich NR4 7TJ, U.K.

4 
``
[From Rick Marken (2007.11.07.1000)]
I was sent a paper recently on the Giffen effect. It's by two Harvard
economists who have actually collected data (in an experiment, yet!)
showing Giffen behavior (increased consumption of a good with increase
in the cost of that good) in a poor population in China.``

Rick,

It seems that the reference signals of the poor Chinese may represent “higher status” or “success” associated with consuming the more costly good.

In the Kingdom of Nepal this phenomena can be seen in the consumption of rice rather than potatoes. Whenever possible, Nepalese prefer to eat more expensive rice (whose growing areas are also more limited than potatoes). Eating potatoes rather than rice as the main dish of a meal is equated with failure. A popular related saying is to say that a person has “Eaten potatoes” is to mean that the person has failed an examination or business activity, for example, or doesn’t have the means to obtain rice.

Is an implication of this that even in an economic world without money, maximization of fancy food eating would occur.

With Regards,

Richard Pfau

···

-----Original Message-----

From: Richard Marken rsmarken@GMAIL.COM

To: CSGNET@LISTSERV.UIUC.EDU

Sent: Wed, 7 Nov 2007 12:58 pm

Subject: Maximization

`
[From Rick Marken (2007.11.07.1000)]
I was sent a paper recently on the Giffen effect. It's by two Harvard
economists who have actually collected data (in an experiment, yet!)
showing Giffen behavior (increased consumption of a good with increase
in the cost of that good) in a poor population in China. I haven't
finished the paper; it's quite long and quantitative (in that way
economists get quantitative, which is difficult for me to get my head
around). But it looks like a great paper and the authors clearly
understand that the Giffen effect is a control phenomenon, resulting
from the need to simultaneously control for consuming a reference
caloric input (what they call "subsistence") while at the same time
controlling expenditures so that don't exceed budget. Once I finish
the article I'll give a little report on what they did. But right now
I'm writing to get some discussion going on the concept of
maximization.
In the Giffen article the authors assume that people act to maximize
things like the amount of "fancy" food they consume. People want to
maximize their consumption of fancy food but those on limited budgets
(poor people) are limited in the amount of such food they can consume
because they have to consume the less preferred food in order to
maintain subsistence. This got me to thinking about maximization. I
can understand why maximization makes no sense in terms of perceptions
like "fancy food"; once you've consumed a certain (reference) amount
of Godiva chocolates, for example, more of that perception just hurts.
So there is clearly a reference for such perceptions. But there are
other perceptions -- like the perception of the size of the number
representing your bank balance -- that can get bigger and bigger and
never produce any pain. So maximization seems to be a reasonable
assumption with some variables, like money, but not others, like the
stuff money represents.
This is my observation. It think that, in an economic world where
there were no money, there would be no behavior that looks like
maximization. Instead, there would be obvious reference settings for
the amount of "stuff" people would want because people would know that
physical constraints (like spoilage) limit the amount of stuff you can
store. For example, you could only store a certain amount of mangos
before some rot. So your reference for mango consumption might be high
but it would not be infinitely high. Money, however, is just a
numerical symbol and there is no physical reason not to have that
number be as big as you can get it to be, ie. to maximize money. Since
economics is largely about money, it's no surprise, then, that
economists would conclude that maximizing (rather than controlling
relative to reference specifications) is what people do.
Whaddaya think?
Best
Rick
-- Richard S. Marken PhD
rsmarken@gmail.com
`

Email and AIM finally together. You’ve gotta check out free AOL Mail!

5

{Jim Dundon 2007. 11.07.1447}

Rick ,

You say that "your reference level for mango consumption might be high but it would not be infinitely high"

That statement indicates the opinion that the reference could be infinitely high

Following that, you say "rather than controlling relative to reference specifications"

The first statement says that the reference can be infinite. The second statement implies that infinite cannot be a reference. Or do you mean to compare finite, not specific, to infinite. Infinite can be a specification.

I also believe that economsts do not mean infinite when they say maximize. I believe thet mean get the best deal.

Consider infinite money as someones goal, would they have time for anything else? No.
Not only that, possesing all the money in the universe woild make it worthless because you would not be using it for trading, because if you did you would no longer have all the money in the universe.

The same real constraints apply to money as apply to mangos.

Best Jim D

···

[From Fred Nickols (2007.11.07.1324 ET)]

Rick Marken (2007.11.07.1000)]

<snip>

This is my observation. It think that, in an economic world where
there were no money, there would be no behavior that looks like
maximization. Instead, there would be obvious reference settings for
the amount of "stuff" people would want because people would know that
physical constraints (like spoilage) limit the amount of stuff you can
store. For example, you could only store a certain amount of mangos
before some rot. So your reference for mango consumption might be high
but it would not be infinitely high. Money, however, is just a
numerical symbol and there is no physical reason not to have that
number be as big as you can get it to be, ie. to maximize money. Since
economics is largely about money, it's no surprise, then, that
economists would conclude that maximizing (rather than controlling
relative to reference specifications) is what people do.

Whaddaya think?

Kinda makes sense to me. Money, as a medium of exchange, has to provide "coverage" for all the many things for which it might be exchanged. Thus, my reference for food might be set in terms of some caloric figure. My reference for shelter might be set in terms of square feet, number of rooms or whatever. Similarly for other "things" and "stuff." The references for these things would indeed have some upper (and lower) limit. But, when it comes to money, it has to cover all those other "things" and "stuff" (e.g., rent or mortgage, grocery bill, gasoline, etc, etc). So, the upper limit of my reference for money overall would be higher than the reference (in money) for any one thing or piece of stuff). That said, I still have some kind of upper limit on my reference for money. This would be the zero error level (the figure at which my efforts to obtain money might fall off or cease). At some point, for me at least, enough is enough. There are, of course, other folks w!
ho meas
ure their worth or esteem or whatever in terms of money and they probably have no zero error level for money.

Anyway, I think money as a medium of exchange has to be equated to other things.

Thanks for the mental nudge...

Regards,

Fred Nickols
nickols@att.net

6

[From Bill Powers (2007.11.07.1441 MDT)]

Rick Marken (2007.11.07.1000) –

Just a brief comment: an effectively infinite reference level for
anything is “more.”

Best,

Bill P.

7

[From Rick Marken (2007.11.07.2150)]

Bill Powers (2007.11.07.1441 MDT)

Rick Marken (2007.11.07.1000) --

Just a brief comment: an effectively infinite reference level for anything
is "more."

Yes, I know. I wasn't questioning the fact that people can act like
they are maximizing in the sense of constantly wanting more. I was
just thinking that it may be easier to act this way with money, which
is just numbers, than with other perceptions. But I think I've
realized that what keeps people from continuously wanting more of any
perception is the simple fact that all perceptions are controlled in
the context of an existing hierarchy of control systems. So I can't
"maximize" my perception of .this great chocolate chip ice cream, by
always controlling for more, because eventually the ice cream fills up
my stomach and becomes a disturbance to other controlled variables,
like my level of stomach distension. I think this can happen with
money too. Once the bank balance gets above a certain level one might
find oneself getting attentions that constitute disturbances to other
controlled variables, like publicity that is a disturbance to one's
desire for privacy or efforts by others to take the money which is a
disturbance to one's interest in keeping it I do think that
controlling for "more" money can get a lot farther than controlling
for the perceptions that the money stands for: the stuff. That is, the
integral of "more" for money can get a lot bigger before it creates a
disturbance to other controlled variables than can the integral of
"more" for the things that money an buy, like ice cream.

Best

Rick

···

--
Richard S. Marken PhD
rsmarken@gmail.com

8

[From Rick Marken (2007.11.07.2230)]

It seems that the reference signals of the poor Chinese may represent
"higher status" or "success" associated with consuming the more costly good.

Is an implication of this that even in an economic world without money,
maximization of fancy food eating would occur.

I'm afraid I confused things. The Giffen effect does not require that
people maximize or seek higher status goods. The Giffen effect, which
the authors of the article claim to be the first to have empirically
demonstrated (and I believe them), is an increase in the consumption
of a good with increases in the price of the good. It was first
described (based on anecdotal evidence) in the late 1800s. The idea is
that consumption of an "inferior" good, like bread, will increase with
price because a consumer on a small budget can no longer afford to get
calories from a preferred good, like meat. This Giffen effect will
only be seen when 1) the consumer needs something in the goods in
order to survive (usually considered to be the calories in food) 2)
the consumer's budget is very limited and 3) the consumer can get all
the calories needed from a mix of bread and meat as long as the bread
is not too expensive. I have a demonstration of the Giffen effect up
on the web at http://www.mindreadings.com/ControlDemo/Economics.html

The article I'm reading tried to demonstrate the Giffen effect in
"real life". And I think they did a pretty convincing job. They
actually found that Chinese peasants decreased their consumption of a
food staple when the price of that staple was _decreased_ by giving
vouchers. The effect was greatest for the poorest peasants. The
results are readily explained by control theory but seem to but kind
of a dent in one of the foundation stones of economics: the law of
demand, which says that there is an inverse relationship between the
price of a good and demand for it. Well, yes, most of the time, I
guess. Maybe the exception proves the rule;-) But saying that that
would be begging the question;-)

Best regards

Rick

···

On Nov 7, 2007 11:43 AM, Richard H. Pfau <richardpfau4153@aol.com> wrote:

--
Richard S. Marken PhD
rsmarken@gmail.com

9

[From Rick Marken (2007.11.07.2240)]

(Jim Dundon 2007. 11.07.1447)

The first statement says that the reference can be infinite. The second
statement implies that infinite cannot be a reference. Or do you mean to
compare finite, not specific, to infinite. Infinite can be a specification.

Yes, I meant the latter. The difference is between a reference for
having $1,000,000 and having a reference for a yearly increase of
$1,000,000.

I also believe that economsts do not mean infinite when they say maximize.
I believe thet mean get the best deal.

Yes. But it's hard to control for that until you know what all the
deals are. You can't control for something when you don't know what it
is. That's why you can't just go out and control for "the best" or the
"biggest" or the "worst". For example, I knew back in 2000 that if
George W. Bush became President he would be really, really bad. Anyone
with half a brain could have known that (yes, it's startling to learn
that nearly half the people in the US are walking around with less
than half a brain, but it explains a lot;-). But what no one, not
even I, could tell back then was that he would be the worst President
of all time. Unfortunately, you have to wait and observe to see what
is actually "best" or "worst".

Best

Rick

···

---
Richard S. Marken PhD
rsmarken@gmail.com

10

[From Bjorn Simonsen (2007.11.08,14:40 EUST)]

from Rick Marken (2007.11.07.2230)

It seems that the reference signals of the poor Chinese may represent

>"higher status" or "success" associated with consuming the more costly

good.

Is an implication of this that even in an economic world without money,
maximization of fancy food eating would occur.

I'm afraid I confused things. The Giffen effect does not require that
people maximize or seek higher status goods. The Giffen effect, which
the authors of the article claim to be the first to have empirically
demonstrated (and I believe them), is an increase in the consumption
of a good with increases in the price of the good.

I agree with both of you. (Hi again Richard. It was nice to live with you in
Manchester).
When economists study the way people satisfy what they call human needs,
they most often think upon physical needs. But I don't think they exclude
needs of psychological character. And I think that one of the reasons they
seldom study the way people satisfy psychological needs is their problem to
find a unit price.

This Giffen effect will
only be seen when 1) the consumer needs something in the goods in
order to survive (usually considered to be the calories in food) 2)
the consumer's budget is very limited and 3) the consumer can get all
the calories needed from a mix of bread and meat as long as the bread
is not too expensive.

I think you are too special saying "The Giffen effect will only be seen when
......". The Giffen effect is seen when a person wishes to buy gold and
weapons. I would better say "The Giffen effect is sometimes seen when ....".
When we (PCT) study the way people control their perceptions, it is no
problem to control our perceptions based by our wishes for bread and meat.
It is neither a problem to control "higher status" or "success". This is
control at a higher level. But the way we control these perception may be by
making use of lower control systems as wishing to by bread and meat.
The problem for PCT is that we don't really know which perceptions people
control. For economists this is not a problem. They control human behavior
(actions). And that is where they are wrong.

I have a demonstration of the Giffen effect up
on the web at http://www.mindreadings.com/ControlDemo/Economics.html

I like all your demonstrations.

[From Rick Marken (2007.11.07.1000)

This got me to thinking about maximization. I can understand why
maximization makes no sense in terms of perceptions
like "fancy food"; once you've consumed a certain (reference) amount
of Godiva chocolates, for example, more of that perception just hurts.
So there is clearly a reference for such perceptions. But there are
other perceptions -- like the perception of the size of the number
representing your bank balance -- that can get bigger and bigger and
never produce any pain. So maximization seems to be a reasonable
assumption with some variables, like money, but not others, like the
stuff money represents.

What you talk about is perceptions in an intrinsic system and in a brain
system. But some people continue controlling perceptions in a brain system
when they don't wish to eat more. I myself buy some bottles of wine and some
boxes of canned products and place them in the cellar, and other people by
several more bottles of wine than I do (for the cellar).
Another place where maximizations seems to be a reasonable assumption is in
sport where money is represented by running 100 meters. I think
maximizations seems to be reasonable assumption with all variables. But
people control different perceptions.

What do you say, Rick?

bjorn

···

On Nov 7, 2007 11:43 AM, Richard H. Pfau <richardpfau4153@aol.com> wrote:

11

[From Bill Powers (2007.11.08.0656 MDT)]

Rick Marken (2007.11.07.2230) –

I think it would be appropriate to acknowledge the late Bill Williams’
priority in analyzing the Giffen effect as a control process. In
fact when he first approached me about PCT, it was to seek my help in
constructing a working computer model of the Giffen Paradox, which we
renamed the Giffen Effect once the model had explained it.

Best,

Bill P.

12

[From Rick Marken (2007.11.08.0915)]

Bill Powers (2007.11.08.0656 MDT)--

Rick Marken (2007.11.07.2230) --

I think it would be appropriate to acknowledge the late Bill Williams'
priority in analyzing the Giffen effect as a control process.

Yes, I think that would be appropriate.

Though I think it is interesting that, despite this, Williams still
maintained a staunchly conventional, non-control theory approach to
economics as a whole.

Best

Rick

···

--
Richard S. Marken PhD
rsmarken@gmail.com

13

[From Rick Marken (2007.11.08.0930)]

Bjorn Simonsen (2007.11.08,14:40 EUST)--

I think you are too special saying "The Giffen effect will only be seen when
......". The Giffen effect is seen when a person wishes to buy gold and
weapons.

Really? Could you describe how the effect works with gold and weapons?
What's the controlled variable (the analog of calories) in that case?

I think maximizations seems to be reasonable assumption with all variables.
But people control different perceptions.

What do you say, Rick?

I say that maximization ("more") or minimization ("less") seems rarely
to be a reference. It does seem to happen in sports, where people are
often trying to do "better" than before (maximize their performance).
I also see it in commerce where the goal is to make "more" money or
pay "less" for a product. But most of the controlling I see seems to
be aimed at achieving or maintaining a perception at a specific
(though possibly varying) reference, as in the PCT prototype of
control: the compensatory tracking task.

Best

Rick

···

--
Richard S. Marken PhD
rsmarken@gmail.com

14

[From Richard Kennaway (2007.11.10.0910 GMT)]

[From Rick Marken (2007.11.07.2230)]
The article I'm reading tried to demonstrate the Giffen effect in
"real life". And I think they did a pretty convincing job. They
actually found that Chinese peasants decreased their consumption of a
food staple when the price of that staple was _decreased_ by giving
vouchers. The effect was greatest for the poorest peasants. The
results are readily explained by control theory but seem to but kind
of a dent in one of the foundation stones of economics: the law of
demand, which says that there is an inverse relationship between the
price of a good and demand for it. Well, yes, most of the time, I
guess. Maybe the exception proves the rule;-) But saying that that
would be begging the question;-)

From David Friedman's discussion of Giffen goods in "Price Theory":

"If Giffen goods are rare or nonexistent, why have I spent time discussing them? The main reason is that in much of economic analysis (including a good deal of this book), we assume that demand curves slope down--that the higher the price of something is, the less of it you buy. If I am going to use that assumption over and over again, it is only fair to give you some idea of how solid it is--by describing the circumstances in which it would be false."

He then proceeds to do so, in mathematical detail. You might try comparing his analysis to that of the paper on Chinese potato-eating.

···

--
Richard Kennaway, jrk@cmp.uea.ac.uk, Richard Kennaway
School of Computing Sciences,
University of East Anglia, Norwich NR4 7TJ, U.K.

15

From David Friedman’s discussion
of Giffen goods in “Price Theory”:

“If Giffen goods are rare or nonexistent, why have I spent time
discussing them? The main reason is that in much of economic analysis
(including a good deal of this book), we assume that demand curves slope
down–that the higher the price of something is, the less of it you buy.
If I am going to use that assumption over and over again, it is only fair
to give you some idea of how solid it is–by describing the circumstances
in which it would be false.”
[From Bill Powers (2007.11.10.0710 MDT)]
Richard Kennaway (2007.11.10.0910 GMT) –
I think that Friedman, along with many other economists, is missing the
main case in which the demand curve fails to slope downward : when you
have as much of something as you want. The “marginal utility”
of a good goes to zero when the reference amount of input is reached, and
becomes negative for larger inputs of the good. The effort expended to
obtain more of the good declines as the amount received approaches the
reference level.
As the price declines, the same effort (expenditure) by an individual
produces more of the good, reducing the error and therefore reducing the
effort. The demand for the good falls as the price decreases, which is to
say that the amount of money spent on the good declines as the price
decreases, declining to zero when the good is free. Since economists
measure demand as the amount spent on purchases, demand declines as price
declines – in any individual.
As far as any one individual is concerned, therefore, lowering the price
of a wanted good will not induce that person to spend more on the good,
but just the opposite. So how did economists get the impression that
lowering prices will increase demand and thus increase income? By looking
at aggregate statistics instead of individual properties.
In a population there will be a distribution of reference levels for any
given good. Some people will want more of one good, some more of another.
Lowering the price on one good means that more people will buy that good
instead of some other good. This is reflected in the indifference curves
of economic theory. If one entrepreneur wants to increase his
sales, he can do so by lowering his prices, and hoping that the ensuing
decline in expenditures by people already buying his product will be more
than offset by the attraction of new customers who had been buying some
other product.
The reason for indifference curves, however, is not not that people are
indifferent to which good they buy, but that they always operate under
budget constraints. When you can obtain only a limited amount of money,
using money to obtain more of one good means that there is less money
available with which to buy any other goods. When a price is reduced on
some good, you can free up money by switching from a different good with
a comparable benefit to the now-cheaper good. If enough people find that
switching is to their advantage, the entrepreneur who lowered his prices
will realize a net increase in income.
Finally, goods are not equivalent in their benefits. Each good is
purchased to satisfy some material or esthetic reference level in each
person. As Bill Williams used to point out, many goods are purchased
simply to stay alive – food, for example. This provides a second set of
constraints to go along with the budget constraints. And this is where
the Giffen Effect arises.
Basically, each person is trying to solve a set of simultaneous equations
such that p[i] = r[i] as nearly as possible: each i-th perception is to
match some reference level for that perception. This is what underlies
indifference curves and other tradeoffs. Some errors, however, are
considered more important than others, which is to say the variables are
controlled with higher gain. It can easily prove to be the case that if
the price of one good being used to control an important perception is
increased, one is forced to buy more of it and less of some other good
that is a more expensive but still desirable way of controlling the same
perception. Bill Williams like to make this point by considering not poor
people struggling to live on potatoes, but rich jet-setters, who are
forced to travel more by commercial airlines when the commercial fares
increase, because even their budgets are not sufficient to allow travel
exclusively by private jet. Everyone has budget constraints of
some kind, and that is all it takes to create the Giffen
Effect.

Best,

Bill P.

···
16

[From Richard Kennaway (2007.11.10.1738 GMT)]

[From Bill Powers (2007.11.10.0710 MDT)]
As the price declines, the same effort (expenditure) by an individual produces more of the good, reducing the error and therefore reducing the effort. The demand for the good falls as the price decreases, which is to say that the amount of money spent on the good declines as the price decreases, declining to zero when the good is free. Since economists measure demand as the amount spent on purchases, demand declines as price declines -- in any individual.

Sorry, this is flat wrong. Demand is measured by quantity of the good itself, not its price.

As far as any one individual is concerned, therefore, lowering the price of a wanted good will not induce that person to spend more on the good, but just the opposite. So how did economists get the impression that lowering prices will increase demand and thus increase income? By looking at aggregate statistics instead of individual properties.

In a population there will be a distribution of reference levels for any given good. Some people will want more of one good, some more of another. Lowering the price on one good means that more people will buy that good instead of some other good. This is reflected in the indifference curves of economic theory. If one entrepreneur wants to increase his sales, he can do so by lowering his prices, and hoping that the ensuing decline in expenditures by people already buying his product will be more than offset by the attraction of new customers who had been buying some other product.

The reason for indifference curves, however, is not not that people are indifferent to which good they buy, but that they always operate under budget constraints. When you can obtain only a limited amount of money, using money to obtain more of one good means that there is less money available with which to buy any other goods. When a price is reduced on some good, you can free up money by switching from a different good with a comparable benefit to the now-cheaper good. If enough people find that switching is to their advantage, the entrepreneur who lowered his prices will realize a net increase in income.

Apart from the mistake of measuring demand by money spent, all of that is standard price theory.

A correction to my previous message. I said (to Rick):

He then proceeds to do so, in mathematical detail. You might try comparing his analysis to that of the paper on Chinese potato-eating.

I misread the text -- he does not in fact discuss the Giffen effect any further than the paragraph I quoted.

···

--
Richard Kennaway, jrk@cmp.uea.ac.uk, Richard Kennaway
School of Computing Sciences,
University of East Anglia, Norwich NR4 7TJ, U.K.

17

Sorry, this is flat wrong.
Demand is measured by quantity of the good itself, not its
price.
[From Bill Powers (2007.11.10.1206 MDT)]
Richard Kennaway (2007.11.10.1738 GMT) –
OK, I’ll take your word for it. However, the gross income to the seller
is the volume times the price, so whatever you call that, according to
control theory it falls (for an existing customer) when the price is
decreased, ceteris paribus.

As far as any one
individual is concerned, therefore, lowering the price of a wanted good
will not induce that person to spend more on the good, but just the
opposite. So how did economists get the impression that lowering prices
will increase demand and thus increase income? By looking at aggregate
statistics instead of individual
properties.

Change “demand” to “gross income to seller” and I
believe that still holds.

The reason for
indifference curves, however, is not not that people are indifferent to
which good they buy, but that they always operate under budget
constraints. When you can obtain only a limited amount of money, using
money to obtain more of one good means that there is less money available
with which to buy any other goods. When a price is reduced on some good,
you can free up money by switching from a different good with a
comparable benefit to the now-cheaper good. If enough people find that
switching is to their advantage, the entrepreneur who lowered his prices
will realize a net increase in income.

Apart from the mistake of measuring demand by money spent, all of that is
standard price theory.

Glad to hear it. But if budget constraints are already part of price
theory, why isn’t the Giffen Effect simply taken for granted? It should
be fairly common.

Does standard price theory predict that when the price is lowered, the
consumers already buying that product will spend less on it rather than
spending the same amount of money and buying more of it? I didn’t realize
that economics includes the idea of a reference level for a product (that
is, a level of consumption of the product at which the person would pay
nothing more to increase it). Does it really? The concept of
“enough” hasn’t been part of any economic theories I have read
about.

My impression from Keynes is that consumption is simply determined by the
available money. Perhaps that applies only to the scarcity economy that
you talked about. Or perhaps that’s just Keynes.

Best,

Bill P.

18

I’m not sure it is wrong. Fred Lee over here at UMKC will talk about the trouble with standard theory in that quantity ultimately has to be measured in dollars–thus creating a ‘mapping problem’ on the standard supply-demand graph. While I’m sure there are occasions on which quantity is measured as units of the particular product, I’m not sure how far you could take any given analysis and maintain this methodology. The BEA’s Input-Output accounts come to mind in this case. It seems to me that showing the relationships between markets/industries will always require some common unit, which is generally a unit of currency. And because we’re talking about buyers switching from one product/market to another given a price change, we must be talking about the relationships between these markets.

erik.

···

On Nov 10, 2007 9:39 AM, Richard Kennaway jrk@cmp.uea.ac.uk wrote:

[From Richard Kennaway (2007.11.10.1738 GMT)]

[From Bill Powers (2007.11.10.0710 MDT)]

As the price declines, the same effort (expenditure) by an
individual produces more of the good, reducing the error and

therefore reducing the effort. The demand for the good falls as the
price decreases, which is to say that the amount of money spent on
the good declines as the price decreases, declining to zero when the

good is free. Since economists measure demand as the amount spent on
purchases, demand declines as price declines – in any individual.

Sorry, this is flat wrong. Demand is measured by quantity of the

good itself, not its price.

19

[From Richard Kennaway (2007.11.11.1057 GMT)]

[From Bill Powers (2007.11.10.1206 MDT)]

As far as any one individual is concerned, therefore, lowering the price of a wanted good will not induce that person to spend more on the good, but just the opposite. So how did economists get the impression that lowering prices will increase demand and thus increase income? By looking at aggregate statistics instead of individual properties.

Change "demand" to "gross income to seller" and I believe that still holds.

It depends (both in the individual and the aggregate) on whether the customer buys more at the lower price. Expenditure might go down, up, or remain the same. There are lots of people who didn't buy the iPhone when it first came out, and did when the price was cut by $200. Their expenditure and consumption of iPhones both went up.

But if budget constraints are already part of price theory, why isn't the Giffen Effect simply taken for granted? It should be fairly common.

The Giffen Effect can only happen when the goods involved take up a substantial portion of one's income. And whether it should be common or not, it can't be if the Stanford paper Rick mentioned is (as they claim) the first definite observation of it, more than a century after the idea was published.

Does standard price theory predict that when the price is lowered, the consumers already buying that product will spend less on it rather than spending the same amount of money and buying more of it?

It predicts that anything might happen, both for the individual and in the aggregate. The range of possibilities is described by the concept of elasticity of demand.

I didn't realize that economics includes the idea of a reference level for a product (that is, a level of consumption of the product at which the person would pay nothing more to increase it). Does it really? The concept of "enough" hasn't been part of any economic theories I have read about.

Perhaps because no-one can ever have enough of everything. Even if you have enough apples, you may still desire better apples. Even if you have explained PCT, you may still desire to explain it better. Even the ascetic living in seclusion desires more enlightenment, and must choose how to spend his time so as best to achieve that. Economics is the study of how we make these choices.

My impression from Keynes is that consumption is simply determined by the available money. Perhaps that applies only to the scarcity economy that you talked about. Or perhaps that's just Keynes.

Perhaps it is just Keynes. He is not well thought of by economists these days -- at least, by the economists I think well of.

···

--
Richard Kennaway, jrk@cmp.uea.ac.uk, Richard Kennaway
School of Computing Sciences,
University of East Anglia, Norwich NR4 7TJ, U.K.

20

As far as any one individual is
concerned, therefore, lowering the price of a wanted good will not induce
that person to spend more on the good, but just the
opposite.
It depends (both in the
individual and the aggregate) on whether the customer buys more at the
lower price. Expenditure might go down, up, or remain the
same. There are lots of people who didn’t buy the iPhone when it
first came out, and did when the price was cut by $200. Their
expenditure and consumption of iPhones both went up.
But if budget constraints are
already part of price theory, why isn’t the Giffen Effect simply taken
for granted? It should be fairly common.

The Giffen Effect can only happen when the goods involved take up a
substantial portion of one’s income.
And whether it should be
common or not, it can’t be if the Stanford paper Rick mentioned is (as
they claim) the first definite observation of it, more than a century
after the idea was published.

Does standard price theory
predict that when the price is lowered, the consumers already buying that
product will spend less on it rather than spending the same amount of
money and buying more of it?

It predicts that anything might happen, both for the individual and in
the aggregate. The range of possibilities is described by the
concept of elasticity of demand.

The concept of
“enough” hasn’t been part of any economic theories I have read
about.

Perhaps because no-one can ever have enough of everything. Even if
you have enough apples, you may still desire better
apples.
Even if you have
explained PCT, you may still desire to explain it better. Even the
ascetic living in seclusion desires more enlightenment, and must choose
how to spend his time so as best to achieve that. Economics is the study
of how we make these choices.

My impression from Keynes is
that consumption is simply determined by the available money. Perhaps
that applies only to the scarcity economy that you talked about. Or
perhaps that’s just Keynes.

Perhaps it is just Keynes. He is not well thought of by economists
these days – at least, by the economists I think well
of.
[From Bill Powers (2007.11.11.0651 MDT)]
Richard Kennaway (2007.11.11.1057 GMT) –
I meant that lowering the price of a good alone will not induce a
control system to spend more money on a good already being consumed (on a
regular basis). The person will spend less, although a slightly larger
quantity of the good will be bought. I did specifically say “spend
more”, not “buy more”. If you leave the properties of the
control system constant, lowering the price increases the loop gain (by
raising the gain of the environmental feedback function, here the ratio
of goods obtained to money spent). Raising the feedback gain increases
the amount of good obtained and reduces the error, and reducing the error
reduces the output of the system, in this case the money the system
spends to obtain the good. So while a slightly larger quantity of the
good will be bought, the result is to spend less money on it. Check out
the Live Block Diagram. Price goes in the environmental feedback
function.

If expenditures change in some other way, that will be because some
aspect of the control system has changed. A higher system, for example,
may raise or lower the reference quantity of the good for reasons related
to fashion, competitiveness, or prestige. The explanation of such changes
has to be different from any purely price-based explanation.

I don’t follow you. I think it depends on how important the goods are to
you, and what higher-order goals they satisfy. If your budget is
essentially unlimited, so you never spend all the money you can get, then
of course the Giffen Effect will never happen, but that condition holds
for very few people. Most people spend all they earn, and enough more to
keep them flirting with debt.

I think there is a Multidimensional Giffen Effect, which starts with the
fact that when prices are raised on some goods and the budget is fixed,
one must reduce other expenditures. If the price of the less expensive
means of error correction goes up, this means that one must cut down on
purchases of the more expensive means and spend more on the less
expensive means. The Giffen Effect arises when prices are raised on the
least expensive means of error correction without making some other
acceptable means cheaper. Then there is no choice but to spend more on
the least expensive good. The Giffen Effect as originally defined is
one-dimensional: bread and meat both supply calories, and there is a
limited budget specifically for calories. Increasing the price of bread
means one must cut down on meat and buy more bread to continue getting
enough calories. But when we broaden the picture to include the
possibility of cutting down on things other than food, we can see that
the Giffen effect can cross the boundaries between kinds of goods: for
example, when the price of prescription drugs goes up, some people have
to spend less on food and more on prescription drugs. Spending less on
food may lead to having to buy more drugs than before – such as
vitamins.

The Giffen Effect applies to individuals; normal supply and demand
applies to populations. As you showed so clearly, relationships seen in
populations have no a priori meaning for individuals, and vice versa.
Economists are concerned primarily, perhaps even exclusively, with
populations, not individuals, so they might never see the Giffen Effect.
You have to consider small groups and the circumstances peculiar to them
to see this effect. And I’m suggesting here that you have to consider
cross-good relationships to see its true extent.

Which means “no”, I guess.

I think that’s a myth we are taught in school that has very little
relation to the way people are actually organized. A person who truly
“maximizes” is probably suffering some form of mental illness.
Control systems do not maximize; as Newell showed, when they are business
managers they “satisfice”, meaning that they set goals and try
to attain them. He got a Nobel Prize in Economics for showing that normal
people are control systems.

There are always errors to be corrected, but this does not imply a
reference condition of “more.” That is a sick reference
condition that can lead only to disaster, whether applied to power, food,
being beautiful, or winning jackpots. Building and creating are joyful
pursuits in themselves, and they do lead to continual improvement of
life, but most of the things in life that we can buy can be obtained in
sufficient amounts to satisfy normal people, who can then turn their
attention to more interesting things. People too poor to do this may have
no apparent limits on what they want, but that is an illusion created by
permanent extreme scarcity. When natural or artificial scarcity abates,
people set goals and satisfy them. They do not maximize. They are control
systems, not maximizing systems.

You know that.

I don’t think well of any economists, including Keynes. None of them
seems to know anything about control theory, and the ones I hear the most
about seem to be concerned mainly with excusing the nasty things done by
capitalists. How about giving me an assignment of reading the work of an
economist you approve of?

Best,

Bill P.