Economics specifically does not make that assumption. You will see it in cost-benefit analysis, but it is not anything like a fundamental assumption in economics. I don't know where you got the idea that it was -- if you learned it from your econ 101 class you should demand your money back.

The fundamental idea in economics is "Pareto efficiency". Something is Pareto efficient if there is a no way to make someone better off without making anyone worse off. An idealized perfectly competitive market would be Pareto efficient, but the bulk of microeconomics these days studies market imperfections.

A level of production is "optimal" if it's Pareto efficient. Again firms in idealized perfectly competitive markets will produce a Pareto efficient output, but real markets can fall short of the ideal. For example, a polluting industry will overproduce, unless pollution is taxed.

IIRC, there are conditions where your alternative criterion matches Pareto efficiency, but they are somewhat special.

Pareto efficient is such a useless concept for any economic controversy; most real world decisions about how to structure society aren't between one Pareto efficient outcome and one non-Pareto efficient outcome, but between two Pareto efficient outcomes with different stakeholders gaining and losing.

If one trillionaire has their every indulgence satisfied, while the rest of the world starves, and our one trillionaire refuses the minor inconvenience of selling off one of their dozen yachts to invest in feeding everyone else? That's a Pareto efficient outcome; you can't make everyone else happier without making the trillionaire slightly less happy. This is a made-up story, but analogous to what actually happens, where there are many, many possible Pareto efficient ways to run the world, but those which privilege the status quo wealthy are always pointed to as somehow imbued with mathematically proven optimality because they are "Pareto efficient".

You mean that right now you think the world is in a Pareto efficient state, and the only question is distribution? You have a much more optimistic view of the world than I do.

Everyone agrees that Pareto efficiency isn't everything. But even there, the Second Welfare Theorem literally tells you how to efficiently redistribute wealth away from the trillionaire, to move to a different Pareto outcome.

Real policymaking is much messier than any of this, of course.

I believe most controversies over how to structure our economy/society/etc are not between "possibility X" and "possibility Y which everyone considers as good as or better than possibility X", given that they are, well, controversies. However poorly one thinks of the masses, Pareto improvements are not the stuff that people argue over; this is a red herring to the substantive questions.

My feelings about all of this, including the Second Welfare Theorem, are roughly those outlined in this post (or rather, series of posts): https://www.interfluidity.com/v2/date/2014/06.

"Most recently, we’ve seen that the 'welfare theorems' — often cited as the deep science behind claims that markets are welfare optimizing — don’t help us out of our conundrum. The welfare theorems tell us that, under certain ideal circumstances, markets will find a Pareto optimal outcome, some circumstance under which no one can be made better off without making someone worse off. But they cannot help us with the question of WHICH Pareto optimal outcome should be found, and no plausible notions of welfare are indifferent between all Pareto optimal outcomes. The welfare theorems let us reduce the problem of choosing a desirable Pareto optimal outcome to the problem of choosing a money distribution — once we have the money distribution, markets will lead us to make optimal production and allocation decisions consistent with that distribution. But we find ourselves with no means of selecting the appropriate money distribution (and no scientific case at all that markets themselves optimize the distribution). We are back exactly where we began, wondering how to decide who gets what."

> Real policymaking is much messier than any of this, of course.

Thanks for your posts which I find interesting. Can you point me to any good sources on crafting better policies?

For context, I'm most interested in better policy choices that generally prioritize 'equal opportunity for all' as opposed to trying to engineer 'equal outcomes for all'.

I don't know a good new source, but there's an old book by Alan Blinder, "Hard Heads, Soft Hearts" that talks about how to take existing policy goals and how to redo them so that they are more economically efficient.

> Economics specifically does not make that assumption.

As everything in economics, it depends on which branch you're talking about, but this assumption is the core of the marginalist revolution which is fundamental to the whole classical branch and it's derivatives, which makes the vast majority of mainstream economics nowadays, because the neoclassical synthesis made the biggest part of the Keynesian school move toward this assumption (say hello to micro-founded macro).

Anecdotally, claims that [insert a foundational hypothesis of classical economics] isn't really that important in the whole model has been the favorite defense of neoclassical economics against criticism since at least Friedman in 53 ( it might have existed before, but none of them had the popularity of his Essays in positive economics)

Classical economics is something different -- think Smith and Ricardo. Marginalism is sometimes called neoclassical, but is distinct from classical economics. The neoclassical synthesis was macroeconomics from the 1940s until the stagflation era. Micro-founded macro was later. I don't think neoclassical has a very clear meaning -- I would call any kind of Keynesianism non-neoclassical, personally.

Anecdotally, it's because so many people are bullshitting when they claim that something is a foundational hypothesis of the mainstream. People prefer to argue against a caricature rather than the real thing.

I don't see how micro-founded macro models equate utility with willingness to pay? Work-horse New Keynesian models begin with a representative agent so willingness to pay of different consumers doesn't even make sense in this context. Moreover, these models are (to my knowledge) seldom used for welfare analysis but rather to examine things like the effects of montetary policy on employment and growth. Models with heterogeneous agents certainly don't assume willingness to pay is the same as utility. I'm an econometrician not a macroeconomist though so perhaps I'm missing something.

They don't equate the two in macro.

> As everything in economics, it depends on which branch you're talking about, but this assumption is the core of the marginalist revolution which is fundamental to the whole classical branch and it's derivatives

Marginalism is saying something much more precise than that. It is saying that (in the given example) the two people value their marginal dollars differently than they value one marginal unit of coffee. A statement which is certainly objectively true, but doesn't capture the apparent contradiction present in the original example.

You seem to talk about Menger's view of marginalism, but Menger isn't really part of the classical branch I am talking about: he founded the Autrian School and was pretty skeptical about the neoclassic school at its time.

I suppose you could be right. My understanding is that literally that is what marginalism is. Where are you getting the idea that there are multiple branches of it?

> Where are you getting the idea that there are multiple branches of it?

That's common economics history: Marginalism was “invented” by Jevons and Menger pretty much at the same time (and Walras came a bit later with no prior knowledge of the two others' work at time of writing).

Jevons' work lead to the birth of the neoclassical school, while Menger's founded the Austrian school, and those two where pretty antagonistic for a while (One of Keynes' biggest achievement is probably the reconciliation these two branches in order to fight against his legacy ;).

This isn't accurate. Whatever Jevons and Menger thought of each other, the Austrians and the British were not completely distinct schools. People would call both groups "neoclassical".

The Austrian school in the modern sense only broke with the mainstream with Keynes. They had their own alternate explanation of the Great Depression that never caught on. I think the leaders of the school just moved to the US and became increasingly dogmatic, so modern Austrianism is a small niche.

There was a more recent form of macro that is anti-Keynesian that can be called "neoclassical", which would be the real business cycle theory, but it doesn't owe much to the modern Austrians. If you want to identify it with a specific marginalist, it's closest to Walras.

> Austrians and the British were not completely distinct schools. People would call both groups "neoclassical".

Nope.

Pareto efficiency might be more useless than "calculate the physics problem assuming air resistance is negligible"

It is exactly as useful. Macroeconomics was completely tangled up until people understood that in a perfectly function economy there was be no business cycle, that even a serious shock would only temporarily slow down the economy. So the focus turned to understanding the market imperfections that make temporary dislocations have such long-term effects.

Physics in idealized situations is incredibly useful, and more importantly, absolutely necessary for understanding non-idealized real situations, so I'm not sure what you're getting at here.

Arrow-Debreu isn't all it's cracked up to be: http://frankackerman.com/publications/economictheory/Interpr...

Can one prove that an idealized perfectly competitive market is Pareto efficient or is this taken as a definition?

There's a proof...

...but then again (1) nobody has ever seen an idealized perfectly competitive market; (2) it's by no means clear that an idealized perfectly competitive market even serves as a useful approximation to the ones we have; (3) efficiency (in the narrow sense defined by efficient markets) is not the goal we want to be pursuing anyway.

There's a proof. The theorem is called the "First Welfare Theorem". There's also a "Second Welfare Theorem" that says that you can achieve any Pareto efficient outcome through a perfectly competitive market and lump-sum taxes.

IIRC Kenneth Arrow proved something around it yes.

There's a branch of economics, usually lumped in with "heterodox economics" that says that interpersonal comparisons of utility are impossible. This is called the Austrian school of economics, whose figures are von Mises and Rothbard.

Their basic unit of the market is the transaction. You know you value the coffee more than $2 and the coffee seller less than $2, and the other person values it more than $1, but until you and the other person actually make a trade you can't figure out the relationship between your preferences. That is, you are exactly right that you cannot say you prefer coffee twice as much.

Here's a video that explains this idea, called "praxeology" in these circles. He explains it in the first five minutes: https://www.youtube.com/watch?v=TI5fjTz1Rbw

Among the first things you learn in microeconomic theory are the expected utility axioms (developed by Von Neumann and Morganstern), and Afriat's theorem. These results give conditions under which an agent's behavior is indistiguishable from utility/expected utility maximization. This is the standard justification for the use of utility maxmization in economics: that it is a good mathematical model of decision making, not that it captures what actually goes on in people's heads. This is not a heterodox idea, it has been mainstream since at least as early as the 1950s. Of course, modern economists like to empirically verify whether these models of decision-making are accurate or whether other behavioral models are more consistent with the data, because economics is a science. Praxeology, on the other hand, is the opposite of science.

This is an example of a weird phenomenon where the heterodox schools of economics argue against a position that hasn't been mainstream in years. In this case, years and years and years. Economics stopped requiring interpersonal comparisons of utility a hundred years ago.

> But to me that doesn't make much sense. What if I am a billionaire and the other person is very poor? It could very well be that the other person values the coffee a lot more than I do, but because I have so much more disposable income than they do I am willing to pay more for it. To me, the assumption should be something like the amount of money as a percentage of my total wealth that I'm willing to pay is equal to the utility of the good.

You're right, it doesn't make sense and it's even worse than you think, because even a given individual doesn't give the same value to something depending on whether they have it (and are asked a price to sell), or not (price to buy).[1]

[1]: https://evonomics.com/resolve-fights-reclining-airplane-seat...

> It could very well be that the other person values the coffee a lot more than I do, but because I have so much more disposable income than they do I am willing to pay more for it.

In doing this (for any resolution of the question), you're making a quantitative comparison of utility between people. That transformation, that $1 for me is the same as $1 for you, is not at all a given -- but it doesn't have to be given, either.

> For example, the definition of an "efficient market" or the optimal level of production of some good both embed this assumption that willingness to pay equals utility.

You're neglecting that there are many possible definitions of 'optimal'. In fact, the fundamental theorems of welfare economics (https://en.wikipedia.org/wiki/Fundamental_theorems_of_welfar...) -- which give us the "market equals optimum distribution" idea -- only give us a Pareto optimal outcome, such that there exists no redistribution of products that would make everyone happier.

Only when we start comparing utility between people can we talk about ways of selecting between Pareto optimums. For example, a market distribution where I owned everything as god-king would be a (morally reprehensible) Pareto optimum, since you couldn't make anyone else happier without leaving me relatively worse-off.

Am I right in thinking that the concept of a social welfare function - which gives us a chance to specify that having you or anyone else as God-king is not the solution we want - is also considered part of welfare economics?

> one is willing to pay for a good is equal to the utility provided by that good [...] then I value the coffee twice as much as the other person > And because this assumption is so fundamental to economics,

That's just plain incorrect, it is not. It might be one of the thoughts that has been used by some economists some time. It is far from any bedrock economic theory.

> Econ 101 is the most I've ever studied the subject.

Well there you go, that is the reason you would think that.

> To me, the assumption should be something like the amount of money as a percentage of my total wealth that I'm willing to pay is equal to the utility of the good.

I think you raise a good objection, but this metric overlooks the concept of leisure as consumption.

Say Alice doesn't like working and chooses to only work 10 hours a week. Whereas Bob really likes material goods and doesn't mind working a lot, so he works 80 hours a week. Bob will have eight times as much money as Alice, and therefore much more money to spend on things like coffee.

But this disparity really does reflect different utility levels for coffee (and other consumer goods). Alice does have less money to buy coffee but that's a downstream manifestation of the result that she genuinely prefers leisure over coffee.

To really get into it you have to start figuring out which wealth disparities are due to genuine differences in preferences (like higher savings rates, longer hours worked, studying harder in school, compensation for stressful or unpleasant jobs, more risk-taking, etc.), and which are due to exogenous factors (like higher intelligence, more opportunities, getting lucky in some endeavor, etc.)

As someone has already commented, the definition of an 'efficient market' in no way equates willingness to pay with utility, and in fact economists seldom make this assumption. Pareto efficiency is very deliberately not utilitarian. A Pareto efficient outcome needn't be a 'good' outcome, it is just an outcome such that no other outcome would make everyone better off. If an outcome isn't Pareto efficient then there is room for improvement. It's worth noting that while Pareto efficiency is central to some very neat foundational concepts taught in introductory econ, modern ecenomic research uses a range of welfare measures to quantitatively evaluate policies. This includes utilitarian welfare analysis. These maybe better capture the actual ethical goals we should have when making policy decisions, but they are usually a bit ad hoc and don't lead to such neat results.

> A bit of a tangent, but something that bothers me is the assumption in economics that the amount of money one is willing to pay for a good is equal to the utility provided by that good.

Some economic analysis uses that (or, rather that willingness to pay is linearly proportional to utility) as a simplifying assumption to make particular problems tractable (or, because the systematic bias it introduces is ideologically preferred by the actor doing the analysis), but it's fairly basic—like, 101 level—economics that aside from the biases introduced by variable wealth that this isn't true because money, like anything else—or, rather, a a direct consequences of this being true for everything money can buy—has declining marginal utility.

it seems like in the event that quadratic payments are applied to a situation where multiple parties are competing for a single good that it reduces to something similar to an auction. Imo it's clear that auctions, corresponding with what you said, favor those with the most income.

Yes, and adding a non-linear transfer function won't help in this case. To win an auction, I only need to outbid you by epsilon. Non-linear payments only help where the value of the thing being purchased can vary (non-linearly) with the purchase price.

can you go into more detail on this? it sounds interesting. What's an example of somethings value that varies non-linearly with the purchase price? Is a "non-linear transfer function" a stand-in for "quadratic payments" in this case?

"Non-linear transfer function" is a generalization of "quadratic payments." "Transfer function" is a general engineering term meaning a mathematical description of the output of a system in terms of its inputs. So the "transfer function" of a payment is its output (what you get) in terms of its input (what you pay). Normally that transfer function is linear: if one apple costs a dollar, then N apples will cost N dollars. (Actually, that's only true up to a point. In the real world, if N is large enough, N apples will cost you less than $N.)

> Imo it's clear that auctions, corresponding with what you said, favor those with the most income.

This seems to boil down to observing that it's good to have money.

You could imagine measuring in terms of each customer's annual incomes. In a year, you might provide value corresponding to 1% of ten customers' annual incomes, or you might provide value corresponding to 1% of a thousand customers' annual incomes. In some sense, in the former case you created a tenth of a person-income of value, whereas in the latter you created a hundred person-incomes worth of value. It'd be an interesting measure.

It would be difficult to make meaningful for a large group because a transfer from A --> B --> C --> D won't measure the same as a transfer from A --> C --> B --> D even though the outcome is equivalent.

Interesting, but if I interpret your assumption correctly it would remove the incentive for people to accumulate more wealth (if everything costs me a % of my net worth, why bother to own more than $1?). Continue the thought experiment and I suspect you'd arrive at some form of Socialism - a topic with a lot of academic material (as you inquired).

Neither does it take into account the ease at which one person can replenish their wealth compared to others (e.g. if rapid enough I can spend 100% of my wealth on every purchase).

But I get where you're coming from in terms of the entrenched economics being imperfect. I thought the end of the article offered some interesting ideas (even if they don't solve your problem), like:

A simple example would be a system where quadratic funding is done retrospectively, so people vote on which public goods were valuable some time ago (eg. even 2 years), and projects are funded up-front by selling shares of the results of these deferred votes; by buying shares people would be both funding the projects and betting on which project would be viewed as successful in 2 years' time.