WEBVTT NOTE Giffen’s Paradox and the Law of Demand 1 00:00:00.000 --> 00:00:30.000 Part of the motivation for the paper is that, you know, in many years of discussing Austrian economics with students, particularly graduate students, at our Rothbard Graduate Seminar, when discussing the differences between the Misesian, Rothbardian approach and the mainstream neoclassical Volrasian approach that most of us are taught in graduate school, one of the questions that consistently comes up relates to the so-called Giffen Good and the decomposition 2 00:00:30.000 --> 00:00:34.780 of Price Change Effects into Distinct Income and Substitution Effects. 3 00:00:34.780 --> 00:00:42.820 According to Mises, the laws of economics are apodictically true, the law of demand 4 00:00:42.820 --> 00:00:48.500 is stated not as a tentative empirical proposition subject to validation, falsification and so 5 00:00:48.500 --> 00:00:53.360 on but as something that is derived from first principles that's praxeologically true. 6 00:00:53.360 --> 00:00:57.920 How can it be, students often ask, how can you claim that demand curves are downward 7 00:00:57.920 --> 00:01:06.920 and Forward Sloping as a Praxeological Truth, when we know there are some rare exceptions, such as the infamous Giffen Good, discussed in Marshall's Principles. 8 00:01:06.920 --> 00:01:13.920 I couldn't find a picture of Sir Robert Giffen. Google Images didn't come up with anything. 9 00:01:13.920 --> 00:01:18.920 I don't know if you guys, any of you have, if you know if his portrait or photograph exists? 10 00:01:18.920 --> 00:01:20.920 If so, I'd love to have a copy of it. 11 00:01:20.920 --> 00:01:29.620 That's a picture from an old story about the Irish potato famine from which the Giffen story is derived, 12 00:01:29.620 --> 00:01:36.620 although apparently the account given by Robert Giffen that is related to Marshall's principles is somewhat fanciful, 13 00:01:36.620 --> 00:01:39.920 according to scholars who have investigated. 14 00:01:39.920 --> 00:01:44.520 For example, Giffen was a very small child during the time of the potato famine 15 00:01:44.520 --> 00:01:52.520 and reported some details as if they were first-hand, with things that a small child wouldn't have possibly known, but that's a subject for another day. 16 00:01:52.520 --> 00:02:07.520 So, you know, part of the background and context here is that, is the idea that the Mangerian tradition, the Austrian tradition, the work coming out of Menger, 17 00:02:07.520 --> 00:02:12.520 is actually quite a bit more diverse and heterogeneous than we often recognize. 18 00:02:12.520 --> 00:02:23.520 That among many contemporary Austrians, Mises, Rothbard are considered sort of standard mainstream figures in Austrian economics. 19 00:02:23.520 --> 00:02:32.520 Mises' views on methodology, on price theory and so on are often taken as sort of the quintessential 20th century Austrian views. 20 00:02:32.520 --> 00:02:37.720 And in fact, there's a lot more heterogeneity in the Austrian School from the very beginning, 21 00:02:37.720 --> 00:02:41.640 from almost the very beginning, at least from the second generation, that one of the great 22 00:02:41.640 --> 00:02:48.640 things in Guido Hulsman's biography of Mises is providing some content about the sort of 23 00:02:48.640 --> 00:02:53.240 milieu in which the Austrian School developed in Vienna and what the early Austrian School 24 00:02:53.240 --> 00:02:59.040 was like and that many of the second, well, many of the third and so-called fourth generation 25 00:02:59.040 --> 00:03:06.040 and Austrians were schooled in a very different approach from that of Mises, which Mises learned from Boehm-Bawerk. 26 00:03:06.040 --> 00:03:17.040 So we begin with the classic de-homogenization by William Jaffe between Menger and the two other marginal revolutionaries, Jevons and Valras. 27 00:03:17.040 --> 00:03:28.040 So we recognize Menger offering a very distinct approach to marginal utility theory, to value and price theory, than did his other marginalist revolutionary contemporaries. 28 00:03:28.040 --> 00:03:36.040 What people often don't recognize is that Menger's unique approach did not become the only approach within the Austrian School. 29 00:03:36.040 --> 00:03:44.040 In fact, one could identify two distinct traditions within the core value and price theory of the Austrian School. 30 00:03:44.040 --> 00:03:52.040 What Joe and I call the causal realist tradition, which starts from Menger and includes, most importantly, Boehm-Bawerk, 31 00:03:52.040 --> 00:04:00.540 The so-called Anglo-American Austrians, Wickstede, Federer, Davenport, to some extent J.B. Clark, and then Mises and Murray Rothbard. 32 00:04:00.540 --> 00:04:07.540 Whereas within the Austrian School, another sort of parallel approach, which we might call the neo-Valrasian tradition, 33 00:04:07.540 --> 00:04:11.040 was very important and influential in the Austrian School. 34 00:04:11.040 --> 00:04:18.040 Wieser himself had a very idiosyncratic position that was based on Menger's insights, 35 00:04:18.040 --> 00:04:24.680 in a very different direction than de Boehm-Bawerk. Schumpeter, of course, was extremely influential 36 00:04:24.680 --> 00:04:30.960 to the Austrians of Hayek's generation, though Schumpeter's own inclination was much more 37 00:04:30.960 --> 00:04:37.760 towards Wieser and even more so towards Walras. Maybe Hayek himself to some extent is in this 38 00:04:37.760 --> 00:04:42.760 neo-Walrasian tradition, sort of an interesting statement in an unpublished fragment that 39 00:04:42.760 --> 00:04:47.560 Hayek drafted in the late 80s for the New Pahlgrave Dictionary, which was published 40 00:04:47.560 --> 00:04:52.560 In 1992, in volume 4 of Hayek's Collected Works, but didn't make it into the New Pall Grave, 41 00:04:52.560 --> 00:04:58.560 he had this very unusual statement, he says, in talking about value and price theory, 42 00:04:58.560 --> 00:05:05.560 he says, equally important is what may well be regarded as the final formulation of the marginal utility analysis by J.R. Hicks. 43 00:05:05.560 --> 00:05:11.560 Of course, he's referring here to the sort of standard neoclassical indifference curve presentation of value theory. 44 00:05:11.560 --> 00:05:41.560 He says, Jair Hickson, the concept of the marginal rate of substitution, based on the indifference curve technique introduced by Irving Fischer and F.Y. Edgeworth, this conception of varying rates of substitution or equivalence, wholly independent of any conception of measurable utility, may well be regarded as the ultimate statement of more than half a century's discussion in the tradition of the Austrian School. That's a very odd statement if you assume that the indifference curve analysis 45 00:05:41.560 --> 00:05:49.560 are somehow distinct or different from Menger's view of value and utility theory. 46 00:05:49.560 --> 00:05:55.560 What do we mean by causal realist analysis? What are its basic features or aspects? 47 00:05:55.560 --> 00:05:58.560 Well, it proceeds along the following steps. 48 00:05:58.560 --> 00:06:06.560 A core idea is this notion of general interdependence among markets, among variables, if you like. 49 00:06:06.560 --> 00:06:10.560 Dr. Blau called it concept of total equilibrium. 50 00:06:10.560 --> 00:06:14.560 Think of it as like a kind of general equilibrium concept 51 00:06:14.560 --> 00:06:18.560 in a very extreme sense. So we start with some initial data, 52 00:06:18.560 --> 00:06:22.560 consumer valuations, people's ordinal preference rankings over 53 00:06:22.560 --> 00:06:26.560 different goods, and stocks of various goods. 54 00:06:26.560 --> 00:06:30.560 In a pure exchange economy, we would start with stocks of goods to be exchanged. 55 00:06:30.560 --> 00:06:34.560 In an economy with production, we would start with goods of factors of production 56 00:06:34.560 --> 00:06:38.560 that can be used by entrepreneurs in the production process. 57 00:06:38.560 --> 00:06:42.560 And so the result is an initial, if you like, equilibrium 58 00:06:42.560 --> 00:06:46.560 of an equilibrium structure of prices and quantities. 59 00:06:46.560 --> 00:06:50.560 Then we employ what Robbins called the method of variations 60 00:06:50.560 --> 00:06:54.560 or what Mises called state of rest analysis and what is more or less 61 00:06:54.560 --> 00:06:58.560 what most of us know as so-called comparative statics, right? 62 00:06:58.560 --> 00:07:02.560 Where we want to understand what is the effect of changing 63 00:07:02.560 --> 00:07:10.000 In one of these initial data, what effect does that have on outcomes? 64 00:07:10.000 --> 00:07:15.600 So we hold everything else constant, we vary this one particular datum, and we trace its 65 00:07:15.600 --> 00:07:18.920 effects in the market. 66 00:07:18.920 --> 00:07:23.000 So again, holding other things equal, we look at the variation in one variable, keeping 67 00:07:23.000 --> 00:07:26.120 everything else constant. 68 00:07:26.120 --> 00:07:28.000 How does this work for value theory? 69 00:07:28.000 --> 00:07:32.160 Well, let's walk through Menger's approach to the law of demand. 70 00:07:32.160 --> 00:07:36.160 Because it really is quite different from the approach that you get in the contemporary textbooks. 71 00:07:36.160 --> 00:07:39.160 So again, Menger starts with a preference ordering. 72 00:07:39.160 --> 00:07:49.160 The consumer has a ranking of different possible courses of action, different goods or bundles of goods that can be consumed. 73 00:07:49.160 --> 00:07:53.160 But there's also the key concept of supply. 74 00:07:53.160 --> 00:07:58.160 And Menger's notion of supply is that in the mind of the individual, 75 00:07:58.160 --> 00:08:05.160 There is a stock, a certain number of units of a good that are perceived to be homogeneous. 76 00:08:05.160 --> 00:08:12.160 So there's a concept of a stock of a good. There must be multiple units of a good which can be employed to alternative ends. 77 00:08:12.160 --> 00:08:18.160 So gallons of water or sacks of wheat or roast beef sandwiches. 78 00:08:18.160 --> 00:08:25.160 So this is still subjective, but in the mind of the consumer, those individual units are identical, equally serviceable. 79 00:08:25.160 --> 00:08:30.060 So they make up the components of the total supply of that good. 80 00:08:30.060 --> 00:08:35.160 And the law of demand, as most of us know it, in the Mangerian fashion, right? 81 00:08:35.160 --> 00:08:41.460 Is that additional units of this homogeneous good, additional units of this stock or supply, 82 00:08:41.460 --> 00:08:46.360 are, you know, allocated to successively lower and lower value uses. 83 00:08:46.360 --> 00:08:49.560 The concept of diminishing marginal utility. 84 00:08:49.560 --> 00:09:03.560 Now, note here that when Menger, in the Mengerian approach, when we talk about diminishing marginal utility, what we really mean is diminishing utility for marginal units of the good. 85 00:09:03.560 --> 00:09:07.640 Okay, so there is no quantity of marginal utility, right? 86 00:09:07.640 --> 00:09:10.920 We're saying that marginal units, additional units of the good, 87 00:09:10.920 --> 00:09:15.920 are allocated to uses that are less valuable to the consumer 88 00:09:17.360 --> 00:09:21.280 than the uses to which the previous units were allocated. 89 00:09:21.280 --> 00:09:23.280 So it's a completely ordinal notion. 90 00:09:23.280 --> 00:09:25.520 There are no quantities of utility. 91 00:09:25.520 --> 00:09:30.360 But it's important to remember that the adjective marginal 92 00:09:30.360 --> 00:09:34.040 applies to the units, not to the utilities. 93 00:09:34.040 --> 00:09:36.720 In fact, the term marginal utility 94 00:09:36.720 --> 00:09:38.840 is a little bit misleading in this context 95 00:09:38.840 --> 00:09:40.240 because many people think of it 96 00:09:40.240 --> 00:09:41.880 in sort of calculus terms, right? 97 00:09:41.880 --> 00:09:44.320 That means the change in total utility. 98 00:09:44.320 --> 00:09:46.620 But in Menger's concept, there is no total utility. 99 00:09:46.620 --> 00:09:48.880 There is only marginal utility. 100 00:09:48.880 --> 00:09:51.760 So you could even say the utility of the marginal unit 101 00:09:51.760 --> 00:09:54.840 or the total utility of the marginal unit, if you like. 102 00:09:56.120 --> 00:09:59.040 So with each additional unit, the utility, 103 00:09:59.040 --> 00:10:04.440 The total utility of that unit is smaller than the utility of the previous unit by virtue 104 00:10:04.440 --> 00:10:09.760 of the fact that it was allocated to a use that was lower on the consumer's valuation 105 00:10:09.760 --> 00:10:10.760 scale. 106 00:10:10.760 --> 00:10:16.600 Now also notice that the concept of marginal utility in Menger's framework only applies 107 00:10:16.600 --> 00:10:20.640 when you have multiple units of a homogeneous good. 108 00:10:20.640 --> 00:10:25.180 So if I only have one potato and one roast beef sandwich and one gallon of water and 109 00:10:25.180 --> 00:10:35.180 and one sack of wheat, it doesn't make any sense to talk about the marginal utility of any of those units because they're all heterogeneous. 110 00:10:35.180 --> 00:10:41.180 So we have to have multiple units of a homogeneous stock for the concept of marginal utility even to apply. 111 00:10:41.180 --> 00:10:44.180 And so Menger gets the downward sloping demand curve. 112 00:10:44.180 --> 00:10:50.180 We get the downward sloping demand curve on the assumption with the idea that the consumer's willingness to pay 113 00:10:50.180 --> 00:10:56.180 for successive units of a homogeneous good goes down as the number of units is increased, okay? 114 00:10:56.180 --> 00:11:06.180 Let's talk for a moment about the sort of Hicks Allen version of utility theory that is in the contemporary textbooks, right? 115 00:11:06.180 --> 00:11:18.180 So the starting point in the neoclassical valuation approach is not units of a homogeneous good, but bundles, heterogeneous bundles of goods, okay? 116 00:11:18.180 --> 00:11:32.180 So in Debreu's theory of value, there's N units of goods in existence, and consumers are assumed to have preferences over all possible combinations or N-tuples of those goods that are existence, right? 117 00:11:32.180 --> 00:11:40.180 So, you know, bundle, if there's three goods in existence, apples, pieces of candy and iPods, right, you can imagine three bundles. 118 00:11:40.180 --> 00:11:47.180 Bundle A is one, one and one. Bundle B is two, one and one. Bundle C is one, two and zero, and so on. 119 00:11:47.180 --> 00:11:58.180 So we think of all possible combinations of these three goods that can exist, and then we ask the consumer to rank each bundle, each one of those three item combos. 120 00:11:58.180 --> 00:12:03.180 So each bundle is heterogeneous, no two bundles are alike. 121 00:12:03.180 --> 00:12:10.180 And we could map them out in a space, let's say we forget about iPods for a minute, suppose there's only apples and candy, 122 00:12:10.180 --> 00:12:40.180 and we can label each bundle on a diagram like this, we can place it in two-dimensional space like this and then we ask the consumer for every pair of bundles, do you prefer bundle A to bundle B, bundle B to bundle A or neither A to B and then we draw, we construct the consumer's indifference map based on the responses to those questions and you have the sort of standard assumptions about the preference ordering that you have to have transitivity 123 00:12:40.180 --> 00:12:45.180 and so on. But again, remember, this is a preference ordering over bundles of goods. 124 00:12:45.180 --> 00:12:52.180 It's not an ordinal preference ranking over heterogeneous, it's not individual units of goods. 125 00:12:52.180 --> 00:12:59.180 So the consumer doesn't have a utility for apples or a utility for candy, right? 126 00:12:59.180 --> 00:13:04.180 The consumer only has preferences over different combinations of apples and candy. 127 00:13:04.180 --> 00:13:16.180 And then, you know, the combinations for which the consumer answers, I neither prefer one to the other, we say, ah, those must lie on the same indifference curve, and we draw indifference curves in the standard way. 128 00:13:16.180 --> 00:13:19.180 Now, how do you get demand curves out of this? 129 00:13:19.180 --> 00:13:28.180 Well, you do this, you start with an initial equilibrium in which there's a ratio of prices. 130 00:13:28.180 --> 00:13:35.180 Prices are represented by the ratio between the price of the good on one axis, the price of the good on the other axis. 131 00:13:35.180 --> 00:13:40.180 And we say, well, let's imagine all hypothetical exchange ratios that could exist. 132 00:13:40.180 --> 00:13:49.180 Give the consumer an amount of money to spend, income, they call it, really more like wealth, it's a stock and not a flow. 133 00:13:49.180 --> 00:13:58.180 And we say, given that amount of money and given a ratio of relative prices, what's the highest indifference curve on which the consumer can pick a bundle? 134 00:13:58.180 --> 00:14:04.180 And then we say, well, what happens if that price ratio were to change? 135 00:14:04.180 --> 00:14:08.180 So, in this example here, I just cut and paste this out of a textbook, right? 136 00:14:08.180 --> 00:14:13.180 So, I guess they have the initial equilibrium is at this point here. 137 00:14:13.180 --> 00:14:20.180 So, you have, so given income and the relative prices represented by this line, 138 00:14:20.180 --> 00:14:25.180 this point right here is the highest point that the consumer, highest indifference curve the consumer can get on. 139 00:14:25.180 --> 00:14:31.180 Say, well, what happens if the price of the good on the horizontal axis increases? 140 00:14:31.180 --> 00:14:39.180 So if the price of product B increases relative to the price of product A, the budget constraint pivots along this point here. 141 00:14:39.180 --> 00:14:43.180 We say, ah, the consumer can no longer afford the original consumption bundle. 142 00:14:43.180 --> 00:14:47.180 Now the best the consumer can do is this point right here. 143 00:14:47.180 --> 00:14:54.180 But notice, in the standard fashion, you say, ah, well, what if we were to vary, oh, sorry, I said this wrong. 144 00:14:54.180 --> 00:14:58.180 Here's the initial, I guess, sorry, it's a decrease in the price of B. 145 00:14:58.180 --> 00:15:09.180 So, starting here with the steeper line, the price of B decreases, the budget constraint becomes flatter, it pivots around this top point, 146 00:15:09.180 --> 00:15:17.180 and we say, well what if we were to vary the price ratio but keep the consumer on the original indifference curve, then where would he be? 147 00:15:17.180 --> 00:15:27.180 Well, if we simply changed the slope of the price line that kept the consumer on his pink indifference curve, then he would consume at a point like this. 148 00:15:27.180 --> 00:15:29.940 So they say, well, here's the substitution effect. 149 00:15:29.940 --> 00:15:32.820 Then allow income to increase, 150 00:15:32.820 --> 00:15:35.740 and you get out here to this final point here. 151 00:15:35.740 --> 00:15:37.500 So this is sort of standard decomposition 152 00:15:37.500 --> 00:15:39.300 of the effects of a price change 153 00:15:39.300 --> 00:15:42.540 into two separate pieces, 154 00:15:42.540 --> 00:15:45.500 a substitution piece and an income piece. 155 00:15:45.500 --> 00:15:48.820 Right, so if you do that, then it's conceivable 156 00:15:48.820 --> 00:15:52.540 under the sort of particular assumptions 157 00:15:52.540 --> 00:15:54.980 that you could actually have an income effect 158 00:15:54.980 --> 00:16:00.580 That's so large, it more than overcomes the substitution effect. 159 00:16:00.580 --> 00:16:10.480 So you have a good that's strongly inferior, like potatoes it is said, it's a large portion of the consumer's budget and so on. 160 00:16:10.480 --> 00:16:23.080 So you can have the substitution effect going from this point to this one, but then an income effect that actually pushes the consumer to a level of the good on the horizontal axis that's lower than it was before. 161 00:16:23.080 --> 00:16:37.080 Right, so the so-called Giffen good case is where the price of the good on the horizontal axis has gone up, sorry, the price has, did I get this wrong? 162 00:16:37.080 --> 00:16:43.080 Yeah, so the price is going down, that's right, the price has gone down, but he's actually consuming less of the good than he was initially. 163 00:16:43.080 --> 00:16:50.080 Okay, so the price has gone down and the quantity demanded has decreased, which sounds like an upward sloping demand curve. 164 00:16:50.080 --> 00:16:58.880 So in the standard Volrasian, Hixian, Dubruvian analysis, what we get, starting with these bundles and the rankings of bundles, 165 00:16:58.880 --> 00:17:05.680 is a kind of a conditional law of demand, where depending on the relative magnitudes of the income and substitution effects, 166 00:17:05.680 --> 00:17:13.980 the sign of the income effect and so on, if the price of a good goes down, the consumer could end up consuming more of that good, 167 00:17:13.980 --> 00:17:19.180 the same amount of the good, or less of the good, depending on the peculiarities of the case. 168 00:17:19.180 --> 00:17:26.580 Okay, so it's a very different notion of a sort of apodictically true universal downward sloping demand curve. 169 00:17:26.580 --> 00:17:29.480 So the demand curve could slope up in this sort of scenario. 170 00:17:29.480 --> 00:17:32.980 Now what's wrong with this? 171 00:17:32.980 --> 00:17:34.780 A few different ways to look at it. 172 00:17:34.780 --> 00:17:38.580 Right, one thing that's, there's a, first there's a kind of circularity here. 173 00:17:38.580 --> 00:17:42.180 And this comes up in sort of neoclassical production theory as well. 174 00:17:42.180 --> 00:17:47.380 Namely that, you know, what we're trying to explain ultimately is prices. 175 00:17:47.380 --> 00:17:53.380 So we say that prices in the market are the outcome of the interactions between supply and demand. 176 00:17:53.380 --> 00:17:55.380 Well, where does demand come from? 177 00:17:55.380 --> 00:18:00.380 Well, the market demand curve comes from a horizontal summation of individual demand curves. 178 00:18:00.380 --> 00:18:02.380 Where do individual demand curves come from? 179 00:18:02.380 --> 00:18:06.380 Well, we start with the preference ordering, the indifference curves and so on. 180 00:18:06.380 --> 00:18:11.380 We walk through the analysis that we've just given, but notice that the analysis on the previous slide said, 181 00:18:11.380 --> 00:18:21.380 I'd said, assume the price ratio is this, and what happens if the price of good B goes down while the consumer increases his quantity or decreases? 182 00:18:21.380 --> 00:18:34.380 Okay, but what made the price go down? Right, so we're starting by assuming prices that change arbitrarily outside the model, use that to derive the demand curve that is then used to explain what the prices are. 183 00:18:34.380 --> 00:18:47.380 So there's a circularity as opposed to a sort of causal analysis that moves from an initial cause to a subsequent effect, which is the way that Menger prefers to approach it. 184 00:18:47.380 --> 00:18:56.380 Just a note on indifference and a note on the potatoes and meat before I turn it over to Joe. 185 00:18:56.380 --> 00:19:10.380 So, again, notice that the neoclassical consumer, right, is ranking heterogeneous bundles, so Menger's concept of marginal utility simply doesn't apply at all in the neoclassical volration case. 186 00:19:10.380 --> 00:19:16.380 There's no marginal utility because there are only heterogeneous bundles. There are no homogeneous goods. 187 00:19:16.380 --> 00:19:27.380 That's not to say, well, in other words, the concept of substitution and income effects doesn't make any sense within the Mungarian tradition. 188 00:19:27.380 --> 00:19:34.380 Now, there is a notion of substitution at the margin in causal realist analysis, a few different notions. 189 00:19:34.380 --> 00:19:39.380 They're not exactly the same as the so-called substitution effect in the volration approach. 190 00:19:39.380 --> 00:19:51.380 Now, when a consumer gives up a unit of good A in exchange for a unit of good B, that tells us that the actor prefers the marginal unit of B to the marginal unit of A that he gave up. 191 00:19:51.380 --> 00:20:04.380 If you want to call that a substitution effect and say, well, the marginal utility of B is greater than the marginal utility of A, and it's sort of almost close to having marginal utilities that are equated at the margin, 192 00:20:04.380 --> 00:20:06.880 But you could say that. It's a little bit misleading, right? 193 00:20:06.880 --> 00:20:11.580 It's better to say the utility of a marginal unit of A, in the case of this exchange, 194 00:20:11.580 --> 00:20:15.480 exceeded the utility of the marginal unit of B, right? 195 00:20:15.480 --> 00:20:20.880 So it's not that one marginal utility was bigger or smaller than another, okay? 196 00:20:20.880 --> 00:20:26.480 Consumer has unequal valuations of the utilities of marginal units of goods. 197 00:20:26.480 --> 00:20:33.380 Now, in a market setting, right, when the price clears the market, right, 198 00:20:33.380 --> 00:20:42.380 It's the case that each buyer values the marginal unit of this homogeneous good that he purchased more than the price that he paid, right? 199 00:20:42.380 --> 00:20:50.080 And each seller values the price received more than the marginal unit of the good, the last unit that he sold. 200 00:20:50.080 --> 00:20:55.980 So there's, you know, there's a kind of equalization across the market, if you like. 201 00:20:55.980 --> 00:21:02.680 That's a loose sense of substitution at the margin or equality at the margin that makes sense within the causal realist approach. 202 00:21:02.680 --> 00:21:07.480 It's very different from the indifference curve version, okay? 203 00:21:07.480 --> 00:21:17.480 Now, finally, you know, people say, well, but isn't it the case that you have these weird situations like the potato famine, okay? 204 00:21:17.480 --> 00:21:26.880 Where, you know, consumers, they were eating potatoes, then the price of potatoes, whoops, price of potatoes went up so much that they had to spend so much money on potatoes, 205 00:21:26.880 --> 00:21:32.680 They didn't have any money left over to buy meat, so they ended up buying even more potatoes than they were before. 206 00:21:32.680 --> 00:21:38.380 So the price of potatoes went up, but that made them so poor that they had to substitute it to even more potatoes. 207 00:21:38.380 --> 00:21:41.280 So isn't that an upward sloping demand curve for potatoes? 208 00:21:41.280 --> 00:21:49.180 So, well, no, it's actually very easy to handle a case like this within the Mangerian tradition and still maintain the view that 209 00:21:49.180 --> 00:21:55.480 still maintain the law of diminishing marginal utility in Manger's formulation and the downward sloping demand curve, right? 210 00:21:55.480 --> 00:22:10.480 I mean, it could very well be that, you know, suppose the market price of potatoes is $1, and the price of meat is $6 per pound, and the consumer has $10, and so at those prices, he buys four potatoes and one pound of meat. 211 00:22:10.480 --> 00:22:19.480 Then the price of potatoes goes up to $2, so to buy four potatoes and one pound of meat would cost him $14, but he doesn't have $14. 212 00:22:19.480 --> 00:22:24.480 So he says, well, I'm just going to skip the meat, I'm going to spend all my money on potatoes, I've got five potatoes. 213 00:22:24.480 --> 00:22:39.480 So the price of potatoes went up and now he's consuming five potatoes instead of four. Isn't that an upward sloping demand curve? No, because what the consumer is purchasing in this example is meat and potato combinations. 214 00:22:39.480 --> 00:22:54.480 Okay, so if at prices of $1 per potato and $6 per pound of meat, the consumer buys four potatoes and one pound of meat, that tells that he has a preference ordering something like this. 215 00:22:54.480 --> 00:23:06.480 His highest, what he values the most is the four potato and one pound of meat combo, just below that is five potatoes, just below that is two potatoes and one pound of meat, and below that is $10. 216 00:23:06.480 --> 00:23:16.480 at the prices such that this bundle costs $10, this is his highest valued end, he gives up the $10, he gets bundle A. 217 00:23:16.480 --> 00:23:23.480 At a price of $2 a potato, he can't even afford bundle A, all he can afford is bundle B or bundle C. 218 00:23:23.480 --> 00:23:30.480 And if forced to choose between five potatoes or two potatoes and one pound of meat at those prices, he prefers five potatoes. 219 00:23:30.480 --> 00:23:40.480 Notice that A, B, and C do not represent units of a stock of a good, but rather heterogeneous bundles. 220 00:23:40.480 --> 00:23:45.480 If you were to perform the experiment, suppose you had heterogeneous meat and potatoes combos, 221 00:23:45.480 --> 00:23:52.480 suppose there's Swanson's steak and potatoes, frozen dinner, and each one is exactly the same. 222 00:23:52.480 --> 00:23:58.480 Even for Marshall's peasant, it would be the case that if he has five of those, 223 00:23:58.480 --> 00:24:10.480 Well, he would eat the first one and he would, you know, give the second one to his wife and he would give the third one to his dog and he would give the fourth one, you know, save the fourth one for later and the fifth one he would use as fishing bait or whatever. 224 00:24:10.480 --> 00:24:16.480 Okay, so he would still allocate each one of those Swanson's frozen dinners to a successively lower valued use. 225 00:24:16.480 --> 00:24:25.480 In other words, the law of diminishing marginal utility still holds for meat and potatoes bundles as long as we keep the characteristics of the bundles the same. 226 00:24:25.480 --> 00:24:40.480 Okay, up to this point our paper was basically based on barter exchange, even though Peter did introduce money at the end as an example. 227 00:24:40.480 --> 00:24:50.480 Now, I wouldn't have used candy and iPods, I would have used magnums of champagne and Broadway tickets, but that's just the difference between us. 228 00:24:50.480 --> 00:25:07.480 But once you do introduce money, and the causal realist always introduces money because we live in a monetary economy and when you purchase anything, you are in effect ranking units of money against units of goods. 229 00:25:07.480 --> 00:25:17.480 So, in that sort of an economy, whenever you purchase, let's say you go and purchase DVDs on sale from Best Buy, 230 00:25:17.480 --> 00:25:30.480 what you do is you buy as many DVDs, or you buy DVDs, excuse me, up to the point where the last DVD would have a lower marginal utility ranking than, let's say, the last $10. 231 00:25:30.480 --> 00:25:39.480 So if you buy three DVDs, that implies that the marginal utility of those DVDs exceed the marginal utility of $10. 232 00:25:39.480 --> 00:25:47.480 Now the point is, once you start talking about the marginal utility of money, you have to have an idea of how much that money can purchase. 233 00:25:47.480 --> 00:25:53.480 Or how much that money, how important is that money to you, that price, that $10? 234 00:25:53.480 --> 00:26:00.280 and that can only be based on some expectation that that money is going to have a given purchasing 235 00:26:00.280 --> 00:26:09.080 power in the market, immediately or at some point in the immediate future. 236 00:26:09.080 --> 00:26:14.160 So now we see that you have a monetary economy and that the marginal utility of money is 237 00:26:14.160 --> 00:26:16.020 very important. 238 00:26:16.020 --> 00:26:23.880 So when we advance to the monetary economy, we have to assume a third datum constant, 239 00:26:23.880 --> 00:26:29.980 and that is the demand for and the supply of money. 240 00:26:29.980 --> 00:26:34.820 That has to be assumed constant, which means that that fixes the purchasing power. 241 00:26:34.820 --> 00:26:39.060 Now that purchasing power, as I said, can be an expected purchasing power. 242 00:26:39.060 --> 00:26:44.720 What will money buy at the point that I'm going into the market? 243 00:26:44.720 --> 00:26:50.960 Now it's necessary to assume purchasing power fixed because without fixed purchasing power 244 00:26:50.960 --> 00:26:58.160 there would be no way to construct or formulate for the actor a coherent value scale upon 245 00:26:58.160 --> 00:27:01.240 which they're going to act. 246 00:27:01.240 --> 00:27:19.200 So the concept of a Giffen good now implicitly violates the setter's power of its assumption 247 00:27:19.200 --> 00:27:25.480 in the method of variations because it allows the demand for money, a basic datum, to change 248 00:27:25.480 --> 00:27:30.200 at the same time that the change in the supply of a particular good is being analyzed. 249 00:27:30.200 --> 00:27:34.440 So we're looking at the overall supply of some good, let's say potatoes, we're allowing 250 00:27:34.440 --> 00:27:42.480 it to increase, and then we're tracing out how the marginal utility will fall on people's 251 00:27:42.480 --> 00:27:44.180 value scales. 252 00:27:44.180 --> 00:27:50.380 If you allow at the same time the purchasing power of money to change, then it may be the 253 00:27:50.380 --> 00:28:00.180 case that money may fall at the same time in marginal utility rankings as the good is. 254 00:28:00.180 --> 00:28:08.180 In which case, you may very well wind up with a situation where you're actually buying more potatoes at a higher price or fewer potatoes at a lower price. 255 00:28:08.180 --> 00:28:14.180 So, there's an implicit violation there. 256 00:28:14.180 --> 00:28:21.180 Very quickly, because we're running out of time here, any economic exchange redistributes income and wealth which causes changes in people's value scale. 257 00:28:21.180 --> 00:28:27.180 So, for example, if we're analyzing an increase in the supply of money, we know, Mises has shown us that money is non-neutral, 258 00:28:27.180 --> 00:28:40.180 So that means when there's an increase in supply of money, it doesn't just raise prices, but at each step, it changes the distribution of wealth, because money is injected at a certain point, and then is spent in a certain sequence. 259 00:28:40.180 --> 00:28:50.180 So the whole distribution of wealth changes, which means that some people who may demand money more, have wealth redistributed in their favor, and others may be disadvantaged by that change. 260 00:28:50.180 --> 00:28:54.340 Now what that could mean is that even though the supply of money has gone up, if the people 261 00:28:54.340 --> 00:28:58.540 who receive a lot of the new money have an increased demand for money or a higher demand 262 00:28:58.540 --> 00:29:02.260 for money than the people who did not receive it, you could get the case where prices do 263 00:29:02.260 --> 00:29:09.180 not fall. Do we say therefore that the demand for money is maybe horizontal? Of course not. 264 00:29:09.180 --> 00:29:15.420 We say all other things given, we abstract from distribution effects, redistributions 265 00:29:15.420 --> 00:29:22.420 of Wealth and Income, we say that if you increase the supply of money, prices will rise. That's just a Ceres Paribus effect. 266 00:29:22.420 --> 00:29:29.420 And in fact, that's why we have an illusion of an upward-sloping supply curve under the Giffen Good. 267 00:29:29.420 --> 00:29:35.420 Because what we're allowing to happen, or what the people who believe in a Giffen Good are allowing to happen, 268 00:29:35.420 --> 00:29:41.420 is that as the price of potatoes goes up, they're implicitly allowing the purchasing power of money 269 00:29:41.420 --> 00:29:47.020 of the the heavy consumers of potatoes to be reduced. Their wealth is being reduced. 270 00:29:47.820 --> 00:29:52.060 So their whole value scale is being revolutionized. It's a different value scale. 271 00:29:52.700 --> 00:29:58.220 So the way to explain this ultimately is to point out that at the same time that the price 272 00:29:58.220 --> 00:30:01.420 of potatoes is falling, that the supply is increased, the price of potatoes is falling, 273 00:30:02.380 --> 00:30:08.540 for those people who buy a lot of potatoes, they're also experiencing at the same time an 274 00:30:08.540 --> 00:30:16.540 and an increase in the demand for potatoes because it's an inferior good, that is, as their income and their wealth falls, they will purchase more of that good. 275 00:30:16.540 --> 00:30:24.540 But overall, I'll end with this. The market demand curve has to slope downward. 276 00:30:24.540 --> 00:30:32.540 And the reason why it has to slope downward is because with the method of variations, you go back to the initial data, you allow one datum to change the supply, 277 00:30:32.540 --> 00:30:39.540 And for that supply to clear the market, when it increases, there has to be a decline in prices. 278 00:30:39.540 --> 00:30:45.540 So the overall market demand curve slopes downward. For segments of the population, it also slopes downward. 279 00:30:45.540 --> 00:30:51.540 However, there's an illusion there because we're allowing wealth and income to be redistributed, 280 00:30:51.540 --> 00:30:55.540 which violates the premise that all other things are held constant. 281 00:30:55.540 --> 00:30:59.540 Okay. Thank you.