This is expressed in the diamond–water paradox, in which Smith pointed out that people need water to live, resulting in a high use value. Yet the rate at which water can be traded for other goods – its exchange value or its price – was very low. Diamonds, on the other hand, had a very low use value compared to water, but a much higher exchange value (Smith [1776] 1976: 34). This paradox created a bit of a sticky contradiction because a good that was essential for life, and which people valued very highly in its use, had a much lower exchange value than a frivolous luxury. For the classical economists, exchange value was easy to measure by looking at the relative prices of two products, but it did not accurately represent the actual value to people. What did represent the actual value to people was particularly individual and, in the words of David Ricardo, “cannot be measured by any known standard” (cited in Stigler, 1950: 311).
The theory of consumption that emerged to dominate economics focused on the decisions of the purchaser and dismissed the difference between use and exchange value. The use–exchange issue was resolved by the neoclassicals by focusing on Jeremy Bentham’s utilitarianism, in which “utility” depends on the pleasure or pain of an activity (Bentham, 1780). In this utilitarian view, there is no distinction between use and exchange value because, if something has a high exchange value, this must be true only because people gain a great deal of pleasure from it. It provides a foundation from which to say that whatever consumers buy is valuable and, conversely, that if there is no market demand for something, it must not be valuable. As University of Chicago economist George Stigler pointed out much later, “Smith’s statement that value in use could be less than value in exchange was clearly a moral judgment, not shared by the possessors of diamonds” (Stigler, 1950: 308).
Three authors – William Jevons ([1871] 1957), Carl Menger ([1871] 2007) and Leon Walras (1954) – independently refined Bentham’s model of a pleasure-seeking, pain-avoiding individual in a manner that won general acceptance in economics. While historians of economic thought are always careful to point out that there were important differences between these three writers, it was what they had in common that created the foundations for the neoclassical theory of consumption. This theory, in which consumers take center stage by sending out signals to which firms respond, is based on a series of assumptions about how people behave and the appropriate level of analysis for the economic discipline. In terms of assumptions about behaviour, people are understood as rational utility maximizers. This means that they have the ability and motivation to understand the utility they receive from their consumption activities, weigh them against the prices being charged, and compare them across purchases in order to generate the maximum utility possible from their consumption budget. People are also assumed to be insatiable – to believe that more is always better, or at least never worse. This does not necessarily mean that they try to consume as many products as possible, but they do attempt to maximize their utility from pleasure-producing consumption while minimizing the amount of pain-producing work effort (we will ignore, for the moment, the potentially problematic double insistence that work is a source of pain while pleasure comes from purchases, which we will take up in chapter 3). This theory also assumes that people’s utility is individualistic in that it stems from their own intrinsic personal benefit from consumption rather than being influenced by others.
How those preferences are formed to create choices of one product over another, or between leisure and consumption, is not really the subject of inquiry. The social, cultural and economic institutions that might affect consumption are not examined by economics, although they might, perhaps, be the legitimate subject of another discipline (Ackerman, 1997: 651). For neoclassical economists such as Gary Becker, these non-economic disciplines can contribute best to social science by figuring out how preferences form, in order that they might be plugged into what he called the “economic approach” in which “all human behavior can be viewed as involving participants who maximize their utility from a stable set of preferences and accumulate an optimal amount of information and other inputs in a variety of markets” (Becker, 1976: 14).
Like Smith, the neoclassical writers put some thought into how the products from which households can choose would be distributed among the population. Walras produced a theory of general equilibrium in which he demonstrated that a competitive market could produce the type and quantity of products that would yield the maximum possible utility for households (Stigler, 1950: 322). “Production in a market governed by free competition is an operation by which the [productive] services may be combined in products of appropriate kind and quantity to give the greatest possible satisfaction of needs” (Walras, 1954: 231). Despite Walras’s claims that his theory was an important step in moving economics in the direction of a pure science, and that it did not contain moral judgements (Hunt, 1979: 267), this was patently not the case, since, like Smith’s, his theory contained the very strong implication that an economy organized as a competitive market would distribute goods among households in a manner that would ensure the most utility. Maximizing the total utility of all members of society is a controversial goal with important moral judgements. Perhaps most obviously, maximizing total utility ignores its distribution between people. If income were redistributed so that it increased the utility of the very rich and decreased the utility of the very poor, this would represent a social improvement as long as the increase for the rich was greater than the decrease for the poor.
Alternative goals which explicitly acknowledge the importance of how income is distributed have been put forward, from egalitarianism to Rawlsian justice (which seeks to ensure a respectable income for the poorest members of society). Notwithstanding these pesky inconveniences to what the neoclassicals viewed as their purely scientific theory of the economy, it was nonetheless true that, as one economic historian put it, Jevons, Menger and Walras opened up a theory of consumption in which individual behaviour should be modelled as “rational, calculating maximization of utility” (Hunt, 1979: 237). These foundations have been further formalized and refined by subsequent authors, particularly Alfred Marshall, who measured the utility of commodities in terms of the price at which they exchanged and argued that the utility of individuals could be added together to measure the utility of all products (Stigler, 1950: 326). “We may regard the aggregate of the money measures of the total utility of wealth as a fair measure of that part of happiness which is dependent on wealth” (Marshall, 1890: 179–80). In other words, the amount of money you spend on a shirt is a direct measure of how much happiness you get out of it. Add up all the spending on shirts, pants, socks, Xboxes, Teslas and the rest, and you get a pretty solid assessment of happiness from all purchased consumption in society. You might also get some joy from picking daisies in a field, but economics hasn’t paid much attention to daisy-picking (at least it didn’t until the economics of happiness emerged and discovered that much of what makes us happy cannot be purchased).
Some of the proponents of the rational maximizing consumer are not completely convinced that it represents an accurate assumption of how people behave. Yet they argue that, despite its lack of realism, it should still be maintained. This point was perhaps most famously made by Milton Friedman (1953), who argued that theories should be judged not on their descriptive accuracy but whether their predictions are successful. So it may not be true that people are actually capable of the complex calculus of genuine rational maximizing, but, because the predictions that follow from assuming that people behave in this manner are accurate, the theory should be judged favourably. Friedman uses the example of a billiards player to illustrate his point. Billiards players do not actually make all the complicated geometrical calculations in preparing a shot. However, if you modelled players “as if” they made these calculations, it would most likely provide a fairly good prediction of the shot that they would actually make. Similarly, consumers may not go through the mental gymnastics required to calculate the utility from different purchases, but if the predictions that stem from modelling consumers “as if” they do yield accurate predictions, then that is a sound basis to accept this assumption.
This particular species of consumer, based as it is on some fairly strong assumptions about human nature, was deemed a sufficiently unique animal that it merited its own scientific name – Homo oeconomicus. Consumers were modelled as (if not actually thought to be) actors capable of making rational choices in order to gain
