A revision of demand theory

206 Pages·1956·5.234 MB·English

by  Hicks, John R.

A REVISIO N OF
D EM AN D TH EO RY
A REVISION OF
DEMAND THEORY
BY
J. R. HICKS
DRUMMOND PROFESSOR OF POLITICAL ECONOMY
IN THE UNIVERSITY OF OXFORD
O X FO R D
AT TH E CLA REN D O N PRESS
Oxford University Press, Amen House, London E.C.4
GLASGOW NEW YORK TORONTO MELBOURNE WELLINGTON
BOMBAY CALCUTTA MADRAS KARACHI LAHORE DACCA
CAPE TOWN SALISBURY NAIROBI IBADAN ACCRA
KUALA LUMPUR HONG KONG
FIRST PUBLISHED 1956
REPRINTED LITHOGRAPHICALLY IN GREAT BRITAIN
AT THE UNIVERSITY PRESS, OXFORD
FROM CORRECTED SHEETS OF THE FIRST EDITION
1959, 1965
PREFACE
The demand theory which I am ‘revising’ in this book is that of
the first three chapters of my Value and Capital·, I have felt
that this theory does need some reconsideration, in the light of
the work which has been done during the seventeen years which
have elapsed since it was first published. I can nevertheless
maintain that the original version stands up to the revision
pretty well. I do not now think that the methodology was quite
as it should have been; some of the treatment was too elliptic,
and some difficulties, which deserved more serious attention,
were brushed aside; most important of all, some opportunities
were missed. I nevertheless expect that there will be some
readers who will continue to prefer the 1939 version. Those
who rely upon mathematical methods will not get much from
the present approach which they could not get from the mathe­
matical appendix to Value and Capital·, but those to whom
those methods are uncongenial, and those who feel that the use
of calculus in economic analysis requires justification (such as it
commonly receives in statistics), are more likely to find that the
present version is an improvement.
I do not wish to present this volume as a mere report on my
own further thinking. It has been profoundly influenced by
others. Such time as I could devote to these matters during the
war years was occupied in working out the consequences of a
most fruitful suggestion by the late Alexander Henderson—a
suggestion which led to my present theory of consumer’s surplus
(Chapters X and XVIII of this book). It was not until 1946 that
I came under wider influences: Samuelson, Lange, Mosak, and
Rene Roy, to name only those who most affected me in this
field at that time. Perhaps I may be allowed to recall an occasion
in the autumn of 1946, at Harvard, when I was called upon to
expound my work on consumer’s surplus to a most select
audience of five or six (which included Samuelson). It was then
that Samuelson showed me how I could get most of my results,
much more simply and neatly, in terms of his (2pq's’; though
on reflection I already felt called upon to reply that there are some
VI PREFACE
purposes for which a marginal analysis remains essential—
especially for the derivation of those properties which depend
upon the use of linear approximations to the marginal curves. In
that discussion the seed of this book was already sown. But as it
has grown in my mind, it has been subjected to other influences:
first of all that of Samuelson’s book (which did not appear until
1947), then of those who may perhaps be called his followers,
among whom Arrow, Little, and Houthakker must be especially
mentioned. It was Houthakker’s 1950 article, with its demon­
stration that transitivity is the ‘logical’ counterpart of integra-
bility, which (from my point of view) supplied the missing link
and tied the whole of the ‘logical’ theory together. All this I owe
to Samuelson and the Samuelsonians, though I can hardly
count myself of their number, since I retain a considerable
scepticism about the ‘Revealed Preference’ approach. It is a
long-standing trouble of demand theory that it is always tempt­
ing us to overplay our hand. I have here attempted to show that
we can interpret the theory in an extremely modest manner, and
still have a theory which will do everything for us that we need
ask of it.
In the autumn of 1951 I gave a course of public lectures at the
London School of Economics, on ‘Demand and Welfare’; in one
of these lectures I gave a sketch of what was to become the
central part of this book. Much of the book was written soon
after that date, but other occupations have caused its completion
to be much delayed. Even now, it has been necessary to postpone
what I have to say on the ‘Welfare’ side to another occasion.
Here I would merely say that my neglect of the ‘Welfare’ side
in this book does not mean that I have not attended to it; I hope
in fact to have a good deal to say about it later on.
Though I have made use of the works of the writers whom I
have mentioned, I am very well aware that there are others,
from whom I could have learned something (perhaps much)
but whose work I have been unable to absorb. Some of these
(such as Wold1 and Stone1) have seemed to me to be mainly
concerned with the statistical application of the theory, rather
than with the theory itself; and that is a matter which I have
1 H. Wold (with L. Jurgen), Demand Analysts.
2 J. R. N. Stone, The Role of Measurement in Economics.
PREFACE yii
felt obliged to regard as being outside my field. But there are
no doubt others for whom I cannot even plead this excuse.
For them I would only say that the time came when my own
construction had to be allowed to take charge: as I learned to
my cost, even quite small alterations (as for instance intermino-
logy) involved the most extensive rewriting. Once the thing
had seriously started its own logic compelled me to continue
writing it in its own way.
Thus the acknowledgements which I have to make are mainly
to those writers whom I have cited above, and to a few others
whose works I cite in the course of the book. But my acknow­
ledgements do not merely extend to their published writings; I
have had the advantage of personal discussion with (I think) all
of the contemporary writers to whom I refer. Even Mr. Ichi-
mura, who plays a considerable part in my Chapter XVII, and
who was for long an exception, dropped in on me from Japan
at a most convenient moment. To all of them I offer my thanks:
as also to Mr. Faaland, of Nuffield College, who read the whole
manuscript in a nearly finished form, and made a number of
most useful suggestions, some of which (even then) I was able to
adopt.
J. R. H.
Oxford
September IQ55
Postscript to Preface {June 1958)
I have taken advantage of this reprinting to make some small
alterations to two passages (on pp. 40 and 71) which have been
subject to particular criticism; and to add a Note at the end of
the book justifying what I have done.
CONTENTS
PartI. FOUNDATIONS
i. The Econometric Approach i
ii. The Measurability of Utility 8
h i. The Preference Hypothesis 16
i v. The Logic of Order 25
v. Strong and Weak Ordering in Demand Theory 36
Part II. THE DEMAND FOR A SINGLE COMMODITY
vi. The Direct Consistency Test 47
vii. The Demand Curve 59
Vili. Indifference and the Compensating Variation 69
ix. Marginal Valuation 83
X. Consumer’s Surplus 95
Part III. THE GENERAL THEORY OF DEMAND
XI. Consistency Tests 107
xii. The Substitution Effect 113
xiii. The Reciprocity Theorem 120
xiv. Secondary Substitution Theorems 130
xv. The Income Effect 136
xvi. Substitutes and Complements in Valuation theory 149
xvii. Complements and Substitutes further considered 161
xviii. Generalized Consumer’s Surplus 169
xix. The Index-Number Theorem 180
xx. Summary and Conclusion 189
index 195
PART I
FOUNDATIONS
I
TH E ECO N O M ETRIC APPROACH
1. By the Theory of Demand, as I shall use the term in this
book, I mean nothing else but the conventional theory of
‘utility’ and consumers’ choice, which finds a place, in some form
or other, in all modern textbooks of economics. I am by no
means concerned to assert that this approach is the only possible
approach to the economics of consumption; it may well be that
at the next round other approaches will have more to offer. But,
even while keeping within the bounds of the traditional theory,
I still feel that I have something to say. Though by now nearly
all the propositions which seem to belong to the theory are well
known to mathematical economists, they are not so well known
to non-mathematicians. I believe that a point has now been
reached when the whole theory can be set out in relatively simple
terms, terms in which the economic significance of what is being
done can be made much more readily apparent. As it is, the
foundations of the theory are still to some extent a matter of
controversy; the fuller statement which is now possible should
clear up some of these methodological controversies also. A
fuller appreciation of what can be achieved in certain directions
helps one to understand the limitations, as well as the strength,
of the general approach.
2. During the three-quarter century of its existence, demand
theory has passed through four recognizable stages. The cul­
mination of the first stage was in Marshall’s Principles (1890).
Behind Marshall we do not need to go, for little which was
written on this subject before Marshall has anything which will
help us here. Marshall, on the other hand, remains classic;
almost everything which Marshall says in his Book III retains
2 THE ECONOMETRIC APPROACH
its validity and requires, in some form or other, to be kept. And
the things which Marshall said were the really important things.
Though the Marshallian core is itself bound to look rather
different when the newer appurtenances have been added to it
than it did when it stood in isolation, we should recognize that
the core is still there. We have come, in some ways, to talk a
different language; but the substance of what we have to say,
over a central part of the field, is the same as what Marshall said.
From this point of view, the work of Marshall’s successors
may be regarded as the extension of his technique to cover more
complicated problems than those with which he attempted to
deal; this, in the end, was precisely what was to come of their
efforts. But in the meantime it often appeared that there was a
more substantial change in approach, ff we take the case of
Pareto, whose Manuel (1906 in its original ftalian version) must
mark our second stage, his essential contribution was to pose the
wider problems. While Marshall’s theory was organized so as to
meet the needs of his partial equilibrium technique (so that he
concentrated attention on the demand for a single commodity in
terms of the rest), Pareto’s was oriented in the direction of
general equilibrium, the set of quantities (of the various com­
modities demanded) depending on the set of prices. Pareto
accordingly thought of Marshall’s theory as being no more than
a special case of his own—as being derivable from his own theory
by letting only one price vary, instead of many prices. But Pareto
did not in fact do as much with the wider problem as Marshall
had done with the narrower. His theory was less operative than
Marshall’s; though he added to our understanding of the work­
ing of the price-system, he did not provide a theory which was
easily capable of being applied. The third stage of development,
which may be taken to run from the celebrated articles of John­
son1 and Slutsky2 up to my own Value and Capital (1939),
accordingly includes a number of attempts to improve upon
Pareto in this particular respect.
It may be claimed that some progress was made by the writers
of this group towards making the Pareto theory more usable,
1 W. E. Johnson, ‘The Pure Theory of Utility Curves’ [Econ. Jour. 1913).
2 E. Slutsky, ‘Sulla teoria del bilancio del consumatore’ (Giornale deglt
Economisti, 1915).
THE ECONOMETRIC APPROACH 3
and at the same time towards weaving the Marshallian and
Paretian threads together. Though the terminology, and the
diagrammatic apparatus, remained Paretian, the substance of
the theory drew steadily closer to Marshall. As time went on,
mere terminological differences were bound to decline in impor­
tance.
From some points of view, and they are important points of
view, that is all that had happened by the end of the third stage.
We were back with Marshall, having reinterpreted him a little
in order to make his theory applicable to more complicated
problems than those with which he wanted to deal. It looked,
and often felt, very like the end of the story.
3. But it was not the end of the story, because of a new de­
velopment, which already affected the work done in the nine­
teen-thirties, and which separates that work, not merely from
Marshall, but from Pareto also. Something had happened which
the newer writers had to take into account, but which the older
writers had not had to take into account. This new development
was the rise of Econometrics.
It is certainly not the case that the econometric reference of
the new theories was at first very explicit. It is not at all explicit
in Value and Capital·, it could hardly have been made so, since
the general course of the argument of that book was to proceed
far away from any econometric application. But it is true that
at crucial points the argument was put in a form which was
influenced by what the econometrists had been doing, and by
the problems which had come up in their work. I think I may
justly conclude that the potential econometric reference was one
of the reasons why the book was as well received as it was. For
whatever we think of the results that the econometrists have
attained, there can be no doubt that econometrics is now a major
form of economic research; a theory which can be used by
econometrists is to that extent a better theory than one which
cannot. The theory which had been reached at the end of the
third stage (roughly speaking, that which is expressed in the
first three chapters of Value and Capital) did at least begin to
have this particular merit.
But it was a defect—a serious defect—that the econometric
reference was not made more explicit. The ideal theory of