Schools Of Psychological Thought

The Psychological School

Schools Of Psychological Thought

The feature of the Psychological school is its fidelity to the doctrine of final utility, whatever that may mean. The older economists had got hold of a similar notion when they spoke of value in use, but instead of preserving the idea they dismissed it with a name, and it was left to the Psychological school to revive it in its present glorified form.

It must not be imagined that the term is employed in the usual popular sense of something beneficial. All that it connotes is ability to satisfy some human want, be that want reasonable, ridiculous, or reprobatory. Bread, diamonds, and opium are all equally useful in this sense.

Nor must we fall into the opposite error of thinking of it as the utility of things in general. Rather is it the utility of a particular unit of some specific commodity relative to the demand of some individual for that commodity, whether the individual in question be producer or consumer. It is not a question of bread in general, but of the number of loaves. To speak of the utility of bread in general is absurd, and, moreoever, there is no means of measuring it. What is interesting to me is the amount of bread which I want. This simple change in the general point of view has effectively got rid of all the ambiguities under which the Classical school laboured.

1. The first problem that suggests itself in this connexion is this: Why is the idea of value inseparable from that of scarcity? Simply because the utility of each unit depends upon the intensity of the immediate need that requires satisfaction, and this intensity itself depends upon the quantity already possessed, for it is a law of physiology as well as of psychology that every need is limited by nature and grows less as the amount possessed increases, until a point zero is reached. This point is called the point of satiety, and beyond it the degree of utility becomes negative and desire is transformed into repulsion. Hence the first condition of utility is limitation of supply.

So long as people held to the idea of utility in general it was im­possible to discover any necessary connexion between utility and scarcity. It was easy enough to see that an explanation that was not based upon one or other of these two ideas was bound to be unsatis­factory, but nobody knew why. As soon as the connexion between the two was realized, however, it became evident that utility must be regarded as a function of the quantity possessed, and that this degree of utility constitutes what we call value.

2. Just as the notion of final utility solved one of the most difficult problems in economics, namely, why water, for example, has less value than diamonds, it also helped to clear up another mystery that had perplexed many economists from the Physiocrats downward, namely, how exchange, which by definition implies the equivalence of the objects exchanged, can result in a gain for both parties. Here at last is the enigma solved. In an act of exchange attention must be focused not upon the total but upon the final utility. The equality in the case of both parties lies in the balance between the last portion that is acquired and the last portion that is given up.

Imagine two Congoese merchants, the one, A, having a heap of salt, and the other, B, a heap of rice, which they are anxious to ex­change. As yet the rate of exchange is undetermined, but let them begin. A takes a handful of salt and passes it on to B, who does the same with the rice, and so the process goes on. A casts his eye upon the two heaps as they begin mounting up, and as the heap of rice keeps growing the utility of each new handful that is added keeps diminishing, because he will soon have enough to supply all his wants. It is otherwise with the salt, each successive handful assuming an increasing utility. Now, seeing that the utility of the one keeps in­creasing, while that of the other decreases, there must come a time when they will both be equal. At that point A will stop. The rate of exchange will be determined, and the prices fixed by the relative measures of the two heaps. At that moment the heap of rice acquired will not have for A a much greater utility than has the heap of salt with which he has parted.

But A is not the only individual concerned, and it is not at all probable that B will feel inclined to stop at the same moment as A; and if he had made up his mind to stop before A had been satisfied with the quantity of rice given him no exchange would have been possible. We must suppose, then, that each party to the exchange must be ready to go to some point beyond the limit which the other has fixed in petto. This point can only be arrived at by bargaining.

3. Another question that requires answering is this: How is it that there is only one price for goods of the same quality in the same market? Once it is clearly grasped that the utility spoken of is the utility of each separate unit for each separate individual it will be realized that there must be as many different utilities as there are units, for each of them satisfies a different need. But if this is the case, why does a person who is famishing not pay a much higher price for a loaf than a wealthy person who has very little need for it? or, why do I not pay more when I am hungry than when I am not? The reason is that it would be absurd to imagine that goods which are nearly identical and even interchangeable should have different exchange values on the same market and especially for the same person. This law of in­difference, as it is called, is derived from another law to which the Psychological school rightly attaches great importance, and which constitutes one of its most precious contributions to the study of economics, namely, the law of substitution. This law implies that whenever one commodity can be exchanged for another for the pur­pose of satisfying the same need, the commodity replaced cannot be much more valuable than the commodity replacing it.

For what is substitution but mutual exchange? And exchange implies equality, so that if there is a series of interchangeable goods none of them can be of greater value than any of the rest.

Consequently, if an individual has at his disposal 100 glasses of water, which is easily available everywhere except in the Sahara, perhaps, no one of these glasses, not even that one for which he would be willing to give its weight in gold were he very thirsty and that the only glassful available, will have a greater value than has the hun­dredth, which is worth exactly nothing. The hundredth is always there ready to be substituted for any of the others.

But the best way of getting a clear idea of final utility is not to consider the value of the object A, but of the object B, which can replace it. . It becomes evident, then, that if I am about to lose some object, A, which I value a good deal but which can be perfectly re­placed by another object, B, that object A cannot be much more valuable than B; and if I had the further choice of replacing it by C, G being less valuable than B, then A itself cannot be much more valuable than C.
We arrive, then, at this conclusion: The value of wealth of every kind is determined by the value of its least useful portion—that is, by the least satisfaction which any one portion of it can give.

Hitherto we have been concerned with the notion of final utility as applied to the problems of value and exchange, but has it the same effect when applied to problems of production, distribution, or con­sumption? The Hedonists have no doubt as to the answer, for what are production, distribution, and consumption but modifications of exchange?

Take production, for example. How is it that under a system of free competition the value of the product is regulated by its cost of production? It is because a competitive regime is by every definition a regime where at any moment one product may be exchanged for another of a similar character, the similarity in this case being simply the result of a certain transformation of the raw material. The law of substitution is operative here, and the reason why cost of production regulates value is that the cost of production at any moment represents the last interchangeable value.

The same is true of consumption, as we can see if we only watch the way in which each of us distributes his purchases and arranges his expenditure. There is evident everywhere an attempt to get the best out of life—to get all the enjoyment which our different incomes may be made to yield; here spending more on house-room and less on food, there curtailing on amusement and extending on charity, until a rough kind of equilibrium is reached where the final utility of the last exchanged objects—or, if another phrase be preferred, the intensities of the last satisfied needs—are equal. If the coin spent in purchasing the last cigar does not yield the same pleasure as the same coin yields when spent on a newspaper, the newspaper will in future probably take the place of the cigar. Consumption seems really to be a kind of exchange, with conscience for mart and desires as buyers and sellers.

Nor is the realm of distribution even beyond the reach of the utility theory. Its application to the problems of interest, wages, and rent is largely the work of American economists, especially of J. B. Clark. It is quite impossible for us to give an exposition of the subtle analyses in which the quarterly reviews of the American universities take such a delight, and which undoubtedly afford a very welcome relaxation in an atmosphere so charged with pragmatism and realism. But we must just glance at the theory of wages. Wages, like other values, must be determined by final utility. But the final utility of what, and for whom? The final utility of the services which the worker renders to the entrepreneur. Following other factors of production, the final produc­tivity of the workers will determine their wages. That is, their final utility is fixed by the value produced by the marginal worker—no matter how worthless he may be—who only just pays the entrepreneur. The value produced by this almost supernumerary worker not only fixes the maximum which the employer can afford to give him, but also the wages given to all the other workers who can take his place— i.e., who are employed upon the same kind of work as his—although they may produce much more than he does; just as in the case of the ioo glasses of water the least valuable glassful determines the value of all the rest.

Thus is the productivity theory of wages at once confirmed and corrected. But this time it is the productivity of the least productive worker, of the individual who barely keeps himself. No wonder the theory has lost its optimistic note. Somehow or other it does not seem very different from the old 'brazen law.'

The rate of interest follows a similar line—the marginal item of capital fixing the rate. It is even more true of capital, which is more completely standardized, with the result that the principle of substitu­tion works much more easily.
Rent is treated at greater length in the next chapter.

Gradually we begin to realize how the observation of certain facts apparently of a worthless or insignificant character, such as the substitution of chicory for coffee or the complete uselessness of a single glove, enabled the Psychological school to propound a number of general theories such as the law of substitution and the doctrine of complementary goods which shed new light upon a great number of economic questions. There is something very impressive about this deductive process that irresistibly reminds one of the genie of the Thousand and One Nights, who grew gradually bigger and bigger until he finally reached the heavens. But then the genie was nothing but flame.