What do Demonstrated Preferences Demonstrate? Expectations!

Murray Rothbard’s disruptive paper, “Toward a Reconstruction
of Utility and Welfare Economics”
has given Rothbardians a foundation for welfare economics which relies on demonstrated preferences. What are demonstrated preferences? As Rothbard explains;

The concept of demonstrated preference is simply this: that actual choice reveals, or demonstrates, a man’s preferences; that is, that his preferences are deducible from what he has chosen in action. Thus, if a man chooses to spend an hour at a concert rather than a movie, we deduce that the former was preferred, or ranked higher on his value scale. Similarly, if a man spends five dollars on a shirt we deduce that he preferred purchasing the shirt to any other uses he could have found for the money.

This gives us an important insight about the nature of exchange. Namely, that if two people participate in voluntary exchange, both will receive that which they prefer in the exchange. If Jones trades $10 to Smith for a radio, Jones demonstrates that he prefers the radio to the $10 and Smith demonstrates that he prefers the $10 to the radio.

But does it mean that both parties benefit from voluntary exchange? There is a subtle but important distinction between the assertion that both parties benefit from their exchange, and that both parties gain that which they prefer. What does it mean to be benefitted by something? As Daniel Hausman and Michael McPherson point out in their book Economic Analysis, Moral Philosophy, and Public Policy (p. 119), what constitutes well-being is not intuitively clear; opinions are widely differentiated. As they explain, some believe that well-being is a matter of relationship with God. Others such as Bentham or Mill believe that well-being is a mental state which they refer to as pleasure and happiness respectively. Others still, such as Nietzsche, reject the mental-state view and believed that great achievements were the mark of well-being. Thus, it is not intuitively clear that getting one’s preferences is equivalent to being benefitted.

But Rothbard clarifies what he means about benefit and well-being. He takes the subjective mental-states view of well-being. That is, that what makes someone better off is subjective to the individual who is making choices. But Rothbard does not immediately equate getting one’s preferences with being benefitted. Instead, he takes the following approach when analyzing voluntary exchange:

Let us now consider exchanges on the free market. Such an exchange is voluntarily undertaken by both parties. Therefore, the very fact that an exchange takes place demonstrates that both parties benefit (or more strictly, expect to benefit) from the exchange. The fact that both parties chose the exchange demonstrates that they both benefit.

This distinction is an important one. According to this analysis, the preferences that people demonstrate are not preferences for that which will benefit them, but for that which they expect to benefit them. This distinction has certainly retained its place within Rothbardian welfare economics. See, for example, Hans-Hermann Hoppe’s essay, “Austrian Rationalism in the Age of the Decline of Positivism” in which he explains that “every voluntary exchange starting from this basis must also be regarded as a Pareto optimal change because it can only take place if both parties expect to benefit from it.”

This has some interesting implications for the way we describe people’s choices. It seems that while we recognize that people expect to benefit from their choices ex-ante, it is only ex-post that we can determine whether or not they do, in fact, benefit. Certainly it is possible that Jones may buy $10,000 of lumber to construct a house which he expects to sell for $20,000 only to find out, once the house is built, that he can only receive a price of $8,000.

This is not a problem for Rothbard’s view of well-being. As Ohad Osterreicher writes in defense of Rothbard, “as economists, we cannot infer anything about ex-post utility from demonstrated preference. This knowledge is barred to us.” He continues with the contention that, “the unhampered market is the best institution for mitigating errors and thus maximizing ex-post utility.”

But the way in which we ordinarily speak about well-being tends to include ex-post benefits. Consider the following example from Hausman’s book chapter, “Mindless or Mindful Economics: A Methodological Evaluation”, of “a healthy and nonsuicidal American tourist named Ellen [who] steps in front of a rapidly moving London taxi”. (If you don’t know, the English never learned that you’re supposed to drive on the right side of the road). Hausman argues that Ellen can be benefitted by coercive action against her: “Suppose that when Ellen sets out to cross the street a helpful bystander grabs her and pulls her back. After the initial shock of having been grabbed by a stranger, Ellen is grateful. But she was nevertheless coerced.”

In this example, Rothbard’s ex-ante account of demonstrated preferences is still completely valid. When Ellen stepped out onto the street she expected to benefit. She thought that she would move towards her end of crossing the street. But it seems that this account of welfare would still lack important features about what we mean when we ordinarily speak about well-being. In this case, Ellen wanted to not be hit by the taxi, but nonetheless the preference she demonstrated was to do that which would lead to her demise. While, ex-ante, we could say that she expected to benefit, it would seem clear that she would not benefit from this action, ex-post.

But demonstrated preference still has great merit! One reason that economists may want to rely on demonstrated preferences and ex-ante expectations of well-being is an epistemological one. Economists cannot know whether or not someone will benefit ex-post from any given choice. Consider the example Ellen once again from the perspective of the bystander. Prior to Ellen crossing the street, he does not know that Ellen is nonsuicidal. Ellen may have wished to kill herself and any continuation of her life would make her worse-off. In this case, by saving Ellen, the bystander has actually harmed her both ex-ante and ex-post. (For argument’s sake we will ignore the well-being of the taxi driver).

This is also true for economists. One’s choices are still indicators of one’s preferences which are defined as that which one expects to benefit from. This might be a sort of “best we can do” for economists. Other attempts to see what one prefers are unreliable. As Rothbard points out, “Consulting [one’s] verbal opinions does not suffice,” since his verbal opinion “might be a joke or a literary game or a deliberate lie.” By demonstrating one’s preferences, we are given concrete evidence about what people expect to benefit from.

Demonstrated preferences still offer epistemologically strong evidence for someone’s ex-ante well-being. But when we are discussing the benefits of mutual exchange, it is important to remember that there is a limit to that which we can claim: in a voluntary exchange, all parties expect to benefit.

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