Saturday, March 21, 2009

Schaeffer: On Subjective Cost

I want to elaborate on a point that seems to be implicit in Justin's post. As Justin put it "Costs are also subjective". In James Buchanan's "little book" Cost and Choice, he distinguishes between costs in a predictive theory of economics, and costs in a more general theory of choice.

In predictive theory, cost is the objectively identifiable measurement of the alternative product that might be produced by reallocating resources. Textbook treatment of cost curves. This market value is reflected in market prices for alternative resources. The movement from predictive theory to a more general theory of choice however, requires making the connection between the costs, who is incurring them, and when.

"The essential element in this concept is the direct relationship between cost and the act of choice, a relationship that does not exist in the neoclassical predictive theory. In the London-Austrian conception, by contrast, cost becomes the negative side of any decision, the obstacle that must be got over before one alternative is selected" (Buchanan, 1999 [1969] pg. 44).

The above quote is another way of discussing the opportunity costs idea that Justin raises. Cost in a theory of choice is felt in utility terms, while in predictive theory it is felt in "commodity terms" -- in other words in terms of other market goods. Expressing costs in forgone alternatives is not "a tautology, and therefore cannot imply anything" (as was suggested here). On the contrary, Buchanan lists 6 rather radical implications that follow from a theory of choice understanding of cost:
  1. Most importantly, cost must be borne exclusively by the decision-maker; it is not possible for costs to be shifted to or imposed on others.

  2. Cost is subjective; it exists in the mind of the decision-maker and nowhere else.

  3. Cost is based on anticipations; it is necessarily a forward-looking or ex ante concept.

  4. Cost can never be realized because of the fact of choice itself: that which is given up cannot be enjoyed.

  5. Cost cannot be measured by someone other than the decision-maker because there is no way that subjective experience can be directly observed.

  6. Finally, cost can be dated at the moment of decision or choice
These ideas of subjective costs grow from a rich tradition coming out of the marginalist revolution and include the ideas of Menger, Wicksteed, Hayek, Robbins, Mises etc. The distinction being drawn here between a predictive / "scientific" / measurable theory and a logical theory of human action is a methodological problem. Austrians get teased for always wanting to talk methodology (a claim that I think is exaggerated), but as Buchanan notes, "this confusion is the source of pervasive error in applied economics"(1999 [1969] pg. 37).

This discussion of costs reflects one of several subtle but important theoretical distinctions that set Austrians apart from others. For instance, measurement is not calculation. Measurable data or information does not allow for what Mises terms calculation. For Mises, measurement implies a fixed unit of measurement (like an inch, a quart, degree or kilometer). Calculation requires market generated prices, which by nature change. I think one way to think about it is that measurement is used in solving 'technological' problems; one end with many different means. Calculation is used in solving 'economic' problems; many ends to be solved with many different means.

Taking on the task of addressing the poor understanding of Austrian ideas reflected in John Quiggin's "critiques", might however be too much for one blogger to take on (at least in this post).


Justin M Ross said...

You bring up the aspect of incidence that I had never recognized before, and I want to wrap my brain around it. Consider the statement:

"The consumer always bears the full cost of a product because they ultimately choose (according to their subjective preferences) the nature and form that the costs take."

What would the Austrian perspective's judgment on this statement be?

Unknown said...

Interesting statement. I think an Austrian perspective on this would be something like the following:

Yes the consumer bears the full cost of a product at the point of sale, but only he knows (or can best anticipate) the full cost. He chooses to bear those costs (in terms of forgone alternatives) when he chooses to trade. This is different than him choosing the nature and form those costs take. The individual is always constrained by time and place considerations to bargaining over the full range or possibilities. But its *because* they ultimately (voluntarily) choose to make the trade off (even if the "nature and form" are not entirely determined by individual preferences) as a result of a higher subjective valuation that they do "incur" the full costs. Splitting hairs?

Anonymous said...

This debate seems, to me at least, to be purely semantics and misunderstanding.

Quiggin appears to be thinking of technological cost while these Austrian arguments, like this post, are referring to cost in the sense of disutility---like opportunity cost.

Is that correct? If so then there really is no debate: technological cost is roughly objective (how many bricks can I physically make out of __ units of stone, chemicals, etc; you're not going to hot chocolate without some water and chocolate) while disutility and opportunity cost change from person to person. Moreover, the "cost" (as in disutility) of something to one person may actually be a benefit to the other!

Perhaps I'm totally missing the point, though....

Anonymous said...

I could agree to all the 6 points here, thanks for posting, I find this very informative!

site said...

Well, I don't really suppose this is likely to have effect.