I recently had cause to re-read part of James Buchanan’s Cost and Choice, which remains one of the most important treatments of the idea of cost in the history of economics. Chapter 3 of the book is the core of his argument and it lays out an important distinction that is often overlooked in other treatments of cost.
Buchanan starts with a methodological distinction between what he calls the “predictive theory” of orthodox economics and the “more general theory of choice.” In a move that can be found elsewhere in his work, Buchanan understands the predictive theory to be the equilibrium models that populate much of formal economics. Those are based on two key assumptions. First, humans are homo economicus, concerned with maximizing utility or profits. Second, they have all of the relevant knowledge necessary to engage in that maximization process. That is, meaningful uncertainty is absent.
If all of the conditions of the predictive theory hold, we can, indeed, predict what people will do facing a particular set of data. As Buchanan notes, in this world, “Individuals do not choose; they behave predictably in response to objectively measurable changes in their environment.” Another way to put this is that if an actor is assumed to maximize utility and that person knows all that is necessary to fill in their utility function, what they will “do” is not a choice. It is simply implied by the maximization assumption combined with those particular data. As we teach in intro, when you know your cost curves and your revenue curves, and are assumed to maximize profits, you don’t “choose” the price and output combination in any meaningful sense of the word. That combination is the logical implication of the location of those curves. Utility and profit maximizers in the predictive theory stand there and can do no other.
The simplest way to see the distinction between the predictive theory and the more general theory of choice is a bit of introspection. When real humans actually make choices, we feel the “agony of choice” that is utterly absent from the predictive theory. Which entrée should I order at the restaurant? Which college should I attend? Which medical treatment should I adopt? All of these choices involve an internal struggle over assessing the costs and benefits and thinking through alternatives, and imagining future regret. The discomfort we experience when facing genuine choice is the result of conflicting goals we might have and the structural uncertainty that is the human condition. Those are all absent in the predictive theory where there are no alternatives to the outcome implied by the data given the maximization and knowledge assumptions.
In the more general theory of choice, human actors are not assumed to only care about pecuniary concerns and they face genuine uncertainty about the future. As Buchanan puts it, in the predictive theory, “cost is reckoned in a commodity dimension” while in the theory of choice it is “reckoned in a utility dimension.” The assumptions of orthodox theory allow us to attach a financial or physical dimension to our understanding of cost, as represented by the marginal cost curves of basic microeconomics. But once we put those assumptions aside, we can only understand cost in utility terms.
This is where Buchanan’s core contribution comes in. What does cost look like in a world where people have multiple goals and are dealing with true uncertainty? Cost in such a world is the actor’s “own evaluation of the enjoyment or utility that he anticipates having to forego as a result of selection among alternative courses of action.” (I would note that it would be more precise to say “want satisfaction” rather than “enjoyment or utility,” especially if “utility” is understood in hedonic terms.) He lays out six implications of what he calls the “choice-bound conception of cost:”
- Most importantly, cost must be borne exclusively by the decision-maker; it is not possible for cost to be shifted to or imposed on others.
- Cost is subjective; it exists in the mind of the decision-maker and nowhere else.
- Cost is based on anticipations; it is necessarily a forward-looking or ex ante concept.
- Cost can never be realized because of the fact of choice itself: that which is given up cannot be enjoyed.
- Cost cannot be measured by someone other than the decision-maker because there is no way that subjective experience can be directly observed.
- Finally, cost can be dated at the moment of decision or choice.
I don’t want to walk through each of these, as I’ve covered many of them in a previous contribution. What I do want to note is that all of these implications derive from the absence of homo economicus and the presence of real uncertainty. This combination makes cost subjective and anticipation-driven. We don’t know for sure whether the steak will be better than the salmon, or whether standard drugs will be better than chemotherapy. Cost is the hurdle we must get over in order to choose. We have to decide that the want we anticipate satisfying by one option is more valuable than what we anticipate from the next best option. That process of weighing those anticipated outcomes is the agony of choice, and it is what is absent from the predictive theory and the standard neoclassical models that emerge from it.
Standard theory might allow us to make predictions about behavior, given its assumptions, but it fails us as a way to understand choice.
Another way to see Buchanan’s contribution is to think in terms of the Austrian idea of discovery and markets as processes of social learning. In the predictive model, there is nothing to discover and there can be no regret. Behavior is implied by the assumptions and the data, and the maximizing combination is always chosen. There is nothing to learn. In the theory of choice, we are always in a process of discovering whether or not the various options in front of us can satisfy our wants in the ways we anticipate. If we choose the steak and it’s not very good, we have learned something for next time we eat at that restaurant. We can experience regret and it can inform future decision making. We learn from our choices and we improve ourselves in the process.
The relationship between cost and real choice Buchanan outlines in his description of the general theory of choice depicts humans who are much closer to the kind of people who inhabit the world of the humanities, and especially the creative arts. They are richly understood humans who experience that agony of choice and face uncertainty about the future. And they are humans who are capable of regret, learning, and improvement. In his essay “Natural and Artifactual Man,” Buchanan writes that “Man wants liberty to become the man he wants to become.” This is a description of the choosing person who inhabits the general theory of choice. The automaton in the predictive theory cannot be understood in those terms.
Whatever the value of the predictive theory, and it certainly has value as a preliminary exercise for understanding economic relationships, it cannot help us to understand genuine choice in a world of uncertainty. And it therefore cannot help us understand the very human experience of the agony of choice, the regret of error, and the joy of learning.