What is the objective?


Jason Collins


January 29, 2011

An economist typically bases their economic models on an assumption that the economy is composed of agents who gain utility from consumption. From the beginning of the model, they take consumption to be the objective and all decisions by the agents aim to maximise their level of consumption within the budget constraint that they face.

While I recently posted on how most economists’ fixation on consumption might be biologically justified, I would like to approach the issue from another angle. To do that, it is worth going back a few years to a 1979 article by Paul Rubin and Chris Paul II on risk preferences.

Rubin and Paul’s starting point is the obvious step (from a biological perspective, not so obvious from an economic perspective) of defining utility as fitness. In their model, utility depends on the number of mates that each man gets.

They then asked what level of income would be required to obtain (or support) one mate. If the man’s income is not enough to attract a single mate, there is no utility from that income. All we have is an angry young man. Once the young man obtains one mate, it would take a very large increase in income to attract a second mate. However, losing a small amount of income and dropping below the threshold could cost them the mate they have.

If obtaining a mate, rather than consumption, is the objective, people would have preferences towards wealth that contrast with the way economists typically assume people react. Changes in wealth below the single mate threshold deliver no utility. An increase in wealth from below to above the threshold delivers a large jump in utility. Further wealth then delivers further incremental increases in utility. Contrast this with taking consumption as the objective, where each increase in wealth would deliver smooth increases in utility.

This difference in objectives can result in significant differences in the decisions taken. Rubin and Paul theorised that where a young male did not have a mate, that individual may be faced with a choice of either undertaking risky behaviour (from the perspective of expected wealth) and possibly accumulating enough wealth to acquire a mate, or undertaking wealth maximising (risk neutral) behaviour and having no mate with certainty. The young male’s action may seem irrational, but it is only through taking the risk that he can possibly reach the required wealth threshold. The safe, steady, low-paying job might normally deliver the highest expected wealth, but it might never be enough.

If this were the case, risk seeking young men would acquire more mates and leave more offspring, leading to the spread of that trait. Once they had attracted a mate, however, the incentives change. They would then seek to minimise risks as there would be little upside. They might lose the wealth necessary to keep their mate. Hence, older people are risk averse.

This risk profile is different to what would be expected from assuming a nice, stable relationship between utility and consumption. By thinking about what their objective might actually be, Rubin and Paul have developed a model which may have more predictive power and better reflect empirical evidence. It delivers a nice illustration that it is worth putting more thought into the assumptions underpinning each model, and at the most basic level, asking what the objective of the agents might actually be.