Psychological Economics

Psychological Economics

Economics tells us the relationship between supply, demand, and price: the higher the supply the lower the price; the higher the demand the higher the price; the higher the price the higher the supply; the lower the price the higher the demand. But what are supply, demand, and price? If by supply we mean the quantity of goods actually available, then the law breaks down in conditions of ignorance: people will not pay a certain price for a good if they don’t believe it has a certain level of scarcity. If you believe potatoes are a scarce commodity, you will pay highly for them (given a certain level of demand) even if they are not in fact scarce; and if you believe that diamonds are common, you will not pay highly for them even if they are in fact scarce. So the law of supply should really be a statement about perceived quantity not actual quantity: price is a function of the perceived amount of a particular good not the actual amount. In conditions of ignorance objective quantity and perceived quantity can come apart, and then price follows perceived quantity. Such ignorance is not uncommon and may be relied upon by suppliers (“Quick while supplies last!”). The underlying law is psychological not psychophysical, and it is robust.

            What is demand? Not overt behavior as such but desire: how much people desire a particular good. If people desire something a lot, they are willing to pay more for it; if less, they are willing to pay less. So price is a function of desire: the more desirable the more expensive. Putting the two laws together, we can say that if people desire a good Gand believe G to be in short supply, then they are willing to pay a higher price for it than if they don’t desire it or believe it to be readily available. Two psychological variables conspire to generate a given price. But what is price? Not just the amount of money (legal currency) a person is asked to pay, since bartering transactions also count as economic—here price would be the amount of a certain good you would be willing to give in exchange (a pint of milk for a bushel of hay, say). But what determines what you would be willing to give in exchange? Clearly it is the sacrifice you would make of other desires you might satisfy given that you make the exchange in question. The more money you give for G the less you have to buy G’, which you also desire. Price is really the amount of desire satisfaction you agree to sacrifice; it is defined in terms of desire dissatisfaction. So the price variable is also psychologically defined. The law of supply thus says that people are willing to have certain desires not satisfied as a function of their beliefs about the scarcity of the good in question (given a fixed level of desire for that good). The law of demand says that people will sacrifice more of their desires the higher their desire for a particular good is, i.e. pay more for it. All of this is purely psychological—supply, demand, and price. The operative economic law is a psychological law relating beliefs and desires. People have beliefs about how rare goods are, as well as desires for those goods and dispositions to favor some desires over others—these psychological facts determine their economic behavior. Economics at the basic level is the study of how these psychological variables interact.[1]

            And not just people, animals too. Suppose a hungry tiger spots a gazelle and wonders whether to give chase: she has a certain level of desire for gazelle flesh and she is aware of the price she will pay by giving chase—exhaustion and the likelihood of injury (she doesn’t desire either of these things). Will she pay that price? Not if she believes gazelles are plentiful and available, and therefore can be obtained at a lower price. She exemplifies the same psychological structure as a human economic agent: supply, demand, and price (desires that will be sacrificed by satisfying the desire for gazelle flesh).[2] She doesn’t tend to go after big fast gazelles because the price will be higher to obtain their flesh, so she makes a calculation about the gazelle before her. Animals are subject to the same “economic” laws as humans when it comes to obtaining goods that incur a certain cost (as in climbing a tree to obtain the luscious fruit near the top). None of this has anything essentially to do with hard currency, industry, exchange rates, banks, etc. Economics is fundamentally about desires, actions, and beliefs regarding availability (especially community-wide beliefs). What sacrifices will I make in order to satisfy a desire, given my beliefs about the availability of the means of desire satisfaction? That is, what price will I pay, given my level of demand and my beliefs about supply? The price a vendor can charge is conditioned by the degree of demand for his product and the buyer’s beliefs about the scarcity of that product. All this proceeds at the level of psychology, so the laws of economics reduce to psychological laws. Economics is a department of psychology—the department concerned with satisfying desires in a social group.

Colin McGinn

[1] There is perhaps some resistance to this way of thinking among economists because it makes their discipline “subjective”, or concerned with the “private”, so they prefer to conceive of it in terms of objective “physical” things. But this is a complete distortion of what economics is really all about—a misguided attempt to emulate physics.

[2] It is true that the gazelle is not a voluntary participant in this interaction, unlike in a typical economic exchange, but that is irrelevant to the laws of supply, demand, and price that the tiger is subject to. These apply whether the other agent benefits from the interaction or not. If I am debating whether to buy a certain car at a certain price, I am only concerned with my level of desire and my beliefs about the scarcity of cars; I don’t care whether there is another agent who will benefit from my purchase. The laws of supply and demand are individualistic in this sense. Since these laws form the core of economics that science reduces to psychology in the manner described.

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