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Thursday, December 03, 2009

My Most Awesomest PrawfsBlawg Post Ever

“Why can’t we end a successful video game series at its peak? Here’s the problem: It’s hard to keep a property fresh and exciting over a long period of time. Memorable gameplay elements are joyful the first time they happen, but their allure wanes each time they are implemented…. Economists call it declining marginal utility.”

-Ben Reeves, "Why Some Franchises Need to Accept Death," Game Informer, Sept. 2009

The idea that the more you have of something, the less the next bit of it is worth, that the next dollar is always worth less to a wealthier person than to a less wealthy person--that is, the idea of declining marginal utility--seems intuitively right, even obvious.  And declining marginal utility is a key assumption in tax policy and scholarship, because (as is probably obvious, and as I will discuss in a future post) it provides an easy justification for redistributive taxation. 

But is it true that everyone experiences declining marginal utility of income?  As I explain after the jump, intuitive support for declining marginal utility is not actually as strong as it might initially seem.  (This is not to deny, however, that while Lego Indiana Jones for the Wii is awesome, it is not as awesome as Lego Star Wars.)

We might begin by noticing that many commodities have declining marginal utility: the first chocolate chip cookie tastes wonderful, the tenth not as good, and the hundredth downright unpleasant.

Cookies  

But not all commodities are like chocolate chip cookies.  Some commodities might even have increasing marginal utility.  You might crave heroin, for example, more and more over time.  And your desire for chocolate chip cookies would change if you could not only eat them, but also trade them for almost anything else.

It does seem, though, that income has declining marginal utility.  If you buy the things you value more first, and buy less important things later, it seems like you must get more pleasure from the first dollars you spend. But this is true only if people's wants and needs don't change.  Rigorous field study (i.e., an interview with my seven-year-old) suggests that desires aren't in fact fixed: 100% of participants in my study wanted Bakugan balls last June and Pokemon cards this September.
First Dollars

A third common defense of declining marginal utility is that some rich people buy very expensive, frivolous, strange things. Malcolm Forbes, for example, threw himself an extravagant 70th birthday party in Morocco that cost about $2 million (in 1989 dollars). Forbes chartered jets to fly 800 friends to Morocco where he presented them with, among other attractions, a firework display, 600 belly-dancers, a staged Moroccan cavalry charge, and Beverly Sills singing “Happy Birthday.”

Surely a dollar that buys a poor person bread does more good than a dollar buys one two-millionth of Malcolm Forbes’ birthday party. But even if comparing the tastes of a few very wealthy people to the needs of the very poor shows that the wealthy (at least, certain very wealthy people) have lower marginal utility than the poor, this doesn't give us a way to compare the marginal utility of the vast majority of income levels, which fall between the extremes of impoverished and blindingly wealthy.

So, if intuition doesn't provide a knock-down argument for declining marginal utility, what do actual studies and research say?  Tune in next time, for what will be, if declining marginal utility always holds, a somewhat less enjoyable post.

Image credits: Cookies: modified and original versions of cobalt123, Epic Cafe Chocolate Chip Cookies (Flickr.com); used under a Creative Commons Attribution-Noncommercial 2.0 Generic license; Bakugan balls: Neeta Lind, IMG-8943 (Flickr.com); used under a Creative Commons Attribution 2.0 Generic License; Pokemon cards: Kichigai Mentat, Pokemon Trading cards; used under a Creative Commons Attribution-Share Alike 2.0 Generic License.

Posted by Sarah Lawsky on December 3, 2009 at 11:48 AM in Tax | Permalink

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Comments

@freight train

Utility is a measure of happiness--so it's a measure of the fulfillment of the heroin addict's desire, not just the quantity of heroin. So it's possible that a certain amount of heroin might give the addict a good amount of utility, until he or she builds up a tolerance. Then, as you point out, it will take more. What this means for marginal utility, I *think*, is that the addicts marginal utility curve for heroin has shifted.

Posted by: GJELblogger | Dec 4, 2009 1:02:39 PM

Here's a question: What is the definition of marginal utility (MU)? In the post you refer to it as what an additional dollar is "worth" to someone. Then toward then end you talk about a dollar that "does more good" for a poor person than a rich person. I think these are two different things.

In the heroin example, it seems MU refers to the degree of craving for heroin, but in the cookie example it refers to the taste - the experience of eating a cookie. What about a heroin addict who has a strong craving for heroin, but hardly gets at all high from the hit due to increased tolerance? Is his/her MU measured across the desire or across the fulfillment of the desire? What's the measure of that "worth?" It seems like there could be a disjunction between degree of desire on the one hand, and degree of satisfaction resulting from fulfillment of that desire on the other. Is MU measured by what someone wants - ie, thinks will result from an additional dollar - or what they actually get from that additional dollar?

I think the answer to that will strongly affect how those curves are drawn; if it's the latter answer, then I think there's a good chance that declining marginal utility is preserved. If it's the first, then I suppose the point is that people's desires can change non-linearly over time, which is fair - but should tax policy be based on what individuals want most? A poor person may feel the lack of a loaf of bread, while a rich person may feel the lack of a private jet, but does that mean that redistributive tax policy needs to respect both desires equally?

Posted by: freight train | Dec 3, 2009 8:08:53 PM

GJELblogger, that's a great point, and it's sort of where I'm headed with all this. In the next few posts, I plan to discuss what tax policy should look like if people don't have uniformly declining marginal utility, if we imagine that some people have utility curves more like the one you've described (i.e., curves that have both convex and concave sections). And I promise you--there will be graphs. (And yeah, I really, really recommend Lego Star Wars for the Wii.)

Posted by: Sarah Lawsky | Dec 3, 2009 5:57:15 PM

I was all set to write this giant comment about the marginal utility of money curve based on my economics degree and a law school discussion of the utility of money as a way to determine tax policy (what base should be taxed at what rate? how much does money mean to any given person?).

But then I realized this is way to complicated to do properly without the ability to draw graphs. But I still want to try to explain an idea anyway.

I have an idea that the utility of money has several curves--when the amount of money you have jumps up by a certain amount, your preferences will change (from inferior goods to superior goods--spam to steak or cheap wine to champagne), putting you on a new curve. I think this is why people at the top of a tax bracket dread being bumped to the next one--their effective tax rate will go up, but their income may have gone up only slightly. And because they're in that new bracket (and maybe on that new marginal utility of money curve), the first dollar of that new bracket has more utility than the last dollar of the previous bracket. It's like being moved from middle class to upper class, but still not being able to keep up with the Joneses.

Also--I imagine that the Star Wars Lego game is amazing.

Posted by: GJELblogger | Dec 3, 2009 5:15:41 PM

Also a bit off point but -- at my seven-year-old's school the progression was Pokemon cards last year, Bakugan this year. Maybe we could work out some trades...

Posted by: Jennifer Hendricks | Dec 3, 2009 1:51:43 PM

Not to your point, but my son LOVES Lego Star wars (the original triology), so I was intrigued by your link.

Posted by: Joseph Slater | Dec 3, 2009 1:28:34 PM

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