I finally got the chance to read The Persistence of Poverty by Charles Karelis. Here is Tyler Cowen’s review. I can’t recommend this book enough. It’s deeply informative, and quite challenging to how we think of ordinary economic decision making theory. It’s a fun ride, and can easily be read in an afternoon.

Karelis proposes we start to distinguish between pleasure goods, and good that are relievers, and realize that some goods can act as both. His thesis is that there is diminishing marginal utility in pleasure goods, but that relievers have increasing marginal utility. “…paying the first bill in a stack of overdue bills does little to relieve a guilty conscience.”

Cake, Screaming

I didn’t quite understand what was going on with it from the book reviews, so let’s do the story with a teensy bit of math.

Here’s the normal story. Picture you are in a room with 10 people. Each of them has a slice of cake. How much you are willing to pay for a slice of the cake is the ‘marginal utility’ of having it, and the more cake you have the less any more cake is worth to you. You’d be willing to pay a $1 for the first slice of cake, but you’d only be will to pay 90 cents for the second slice. You’d only be willing to pay 10 cents for the 9th slice, and a penny for the 10th slice. Eating the 10th slice of cake in that room would probably make you sick, hence you want it a lot less than the first slice, which is delicious. That’s declining marginal utility.

Now picture you are in a room with 10 people screaming. You hate it when people scream, and you can pay a person to get them to stop screaming. Would you pay in a similar way to the cake example? Would you pay a $1 to get the first person to stop screaming, and a penny for the 10th person to stop screaming?

No. Getting one person to stop screaming would make very little difference in how much you dislike being in the room. Modern psychology tells us you might not even notice it. You’d probably only pay a penny to get that first guy to stop screaming. However getting the second guy to stop screaming might be worth 10 cents. And the last guy, the difference between some screaming and no screaming, might be worth the full dollar to you. The more quiet it got, the more a marginal difference in how quiet it is would be worth to you. There’s increasing returns to this good; the 10th guy not screaming is worth more than the first guy not screaming, which is the exact opposite dynamic of the 10th cake being less delicious than the first.

For those not involved with economic theory this might just elicit a shrug, but this mechanism turns everything on its head. Let’s say that instead of money, you are given 20 tokens to be used over 4 days, and each token gets you one slice of cake in room #1, and one person to stop screaming in room #2. In the cake room, the optimal decision is to consumption smooth – eat five slices of cake each day, so you use the tokens {5,5,5,5}. In the screaming room, all the enjoyment is not in getting a room with half screaming but in getting a quiet room, and instead of consumption smoothing the optimal choice is to binge – pay 10 people to stop screaming the first two days, and deal with a loud room the last two days – {10,10,0,0}. This will hold even with ‘nudges’, say offering two extra tokens if you have people consumption smooth, since the marginal utility isn’t increasing that much. The utility of {10,10,0,0} is greater than that of {5,5,5,7}.

(And most interesting, instead of tokens, let’s say you could work an hour for 1 token or take 65 cents in leisure over a 5 hour day. In the cake room, you’d probably work 3 hours, and relax 2 hours, as around that time you’d have the marginal return from cake equally the marginal return from relaxing. In the screaming room, you probably wouldn’t work at all – it’s impossible enough to make enough to stop the screaming to the point where it is worthwhile to try. Hence the persistence of poverty.)

His other point is that many goods have both characteristics. Let’s say you have 5 children. In a large house, where each child has his or her own room, a child leaving the house to go out into the world gives you diminishing marginal utility. The first room turns into an entertainment center, the second into a hobby room, and the third just sits empty. But if you are in a cramped, small 2 bedroom place for all of you, the first child leaving might only make a slight bit a difference compared to the second child leaving. By the time the 5th child leaves the home, you get the most marginal enjoyment of having your small place less cramped. Karelis point is that this inflection point is where we should be thinking about poverty, because as the token example above mentions, normal policy mechanisms based on neoclassical microeconomic theory won’t necessarily hold.

Intellectual History

Karelis takes a moment to do some intellectual history digging and finds that the current economic obsession with decreasing marginal utility comes from Jeremy Bentham’s equating happiness with the absence of unhappiness. Bentham, and the Mills, thought of happiness as reciprocal to unhappiness, like the relationship between tall and short. So to increase happiness is the same exact thing as to decrease unhappiness. Maybe, maybe not. But the problem is that this relationship is carried over to the goods that effect happiness and unhappiness.

Bentham: “utility [is] that property in any object whereby it tends to produce…pleasure…or happiness..or (what comes to the same thing) to prevent the happening of mischief, pain, evil, or unhappiness.” Stanley Jevons cites that passage 80 years later when he lays the foundation of what Alfred Marshall will later use to create modern economics.

Bentham usually showed a more ambiguous approach, noting that there are often ranges of postive experiences and negative experiences that don’t necessarily net, but that ambiguity hasn’t transfered to the current theory where the marginal rate at which pleasers please is information on the rate at which relievers relief. And this approach, to see a cross-section within time and see that a baseline income can change incentives in a dramatic way, is a whole new dimension to think through. And one with very testable hypotheses.