Utility Can be Dropped

Chapter 4, Section 7: Utility Can be Dropped

Let's get back to the concept of "utility". Although it's been popular in economics for quite long a time, I've decided not to use it any more after careful consideration. That's because the concept is a castle in the air, only an imaginary abstraction by economists, and doesn't exist in the real world; invisible means untestable, so it cannot be used in implication validation. From the viewpoint of economic explanation, when one more censer added one more ghost would have to be serviced, unobservable variables thus shall be avoided as much as possible. “Utility" is right so.

Years ago my teacher Alchian was with Becker and Friedman, and insisted "utility" be reserved. His reason was many economic goods, like friendship,  reputation and etc., cannot be traded on the market and therefore unmeasurable with money. Teacher Alchian called them non-pecuniary goods and thought only utility can be used for their measurement. After days of consideration, I had my conclusion for this problem: it's correct that some goods are not exchangeable on the market and thus don't have market price, yet economics has the postulate of substitution, and the so-called non-pecuniary goods can be mutually substituted with other pecuniary goods, so through the price changes of pecuniary goods we can still predict or explain the choice behaviors about those non-pecuniary goods. For example, now revising my Economic Explanations, I've increased my time spending measurable with money, and reduced the time chatting with my children about their life. The latter can be viewed as a loss of care to them, a non-pecuniary good. In the previously mentioned paper I published in 1972, my analysis of phenomena like children property rights, divorce, and child wife in old China all avoided any use of the utility concept.

I think, utility theory is popular in economics is mainly because the theory can provide a large room for the use of math formulas, which make papers look professional and easier to publish. Becker is the best of nowadays at the use of utility functions, and his analysis capability tops everyone I've seen. Yet I don't think good of his explanation capability: his predictions of worldly affairs usually go wrong. Utility is not something real, that makes the theory's implications need more steps before becoming testable, and one is very easy to make tautological mistakes in the course of reasoning. Asserting behaviors like jumping off a building, getting divorced, killing one's children, etc., are utility maximizing, cannot be wrong. But that's just a tautology. Of course Becker can't be this stupid, but you students shall realize in utility analysis it's very very easy to make such mistakes, and in fact gentlemen that's been set up are countless.

Alchian once had it quite right, that to explain human behaviors with utility analysis requires two conditions: first, we need to know how to rank different options with utility numbers; second, we need to know the sacrifice that has to be made for each option. I agreed, yet my reply was: if we know these, we don't need the concept of utility.

Inferior goods and Giffen Paradox

Chapter 4, Section 6: Inferior goods and Giffen Paradox

The concept inferior goods of economics is translated as "cixuan wupin", something inferiorly chosen, by Hong Kong education authorities, which is wrong! In mainland China it's translated as “didang wupin”, something low end, or "liezhi wupin", something low quality, which are wrong as well! My translation is "pinqiong wupin", which means poverty goods, though indecent yet correct.

What is an inferior good? I don't have a high income, so I drink beer, yet yesterday I won one hundred grand in my horse bet, which is a large amount, then I turn to drink wine. It's quite normal that one drinks beer when he is poor, and once income increased starts to drink wine. If the quantity demanded for a good reduces due to income increase, it's called inferior good. The beer above doesn't have to be low quality, inferiorly chosen, or low end at all. It can be excellent and wonderful, but I'd only drink more when I lose in horse bets, or when I am poor.

That's to say, when the relative price of beer and wine remains unchanged, the increase of my income can change my marginal rate of substitution, and lead to a decrease of the quantity demanded for beer. Logically, any good can be inferior good, and whether it is or not just depends on everyone's different choice.

The phenomenon above and its indubitable logic brings a great problem to economics. During the entire utility analysis, we have only three safe postulates: first, everyone maximizes his utility; second, the postulate of substitution; and third, the convexity postulate. These three are all constraints on behaviors, but since utility and indifference curve are only abstract and unobservable, they cannot give many potentially refutable implications and are not that useful in behavior explanation.

We thus need a postulate stronger enough to solve the difficulty caused by this unreal concept of "utility". We ask: when the sacrifice to obtain some economic good reduces, would one's quantity demanded for the good definitely increase? This is the heart of economics, and intuition seems telling us: of course it would! However, with only the above three postulates, the transition from the change in sacrifice to that in quantity demanded is not justifiable.

Let's take price as the sacrifice. When the price of an economic good reduces, by convexity postulate the quantity demanded for that good must increase, however a same indifference curve must be assumed. When the price of the good reduces, consumers of that good will have a increase in their real income, therefore the utility they maximize would be higher. A reduction in price originally enlarges the quantity demanded for that good, yet the accompanying increase in income or utility can either enlarge or decrease the quantity demanded — the decrease is right caused by "inferior good".

When the price of an inferior good reduces, the reduction itself enlarges the quantity demanded for the good, yet the price reduction leads to an increase in real income, and further to a decrease in the quantity demanded. Combined together, one plus and one minus, the quantity demanded can still increase. However, logically one plus and one minus can lead to a total decrease in the quantity demanded as well. The latter case is right the well-known Giffen paradox.

This was written in the third version (1895) of A. Marshall's Principles of Economics. Sir Robert Giffen (1827-1910) gave Marshall a paradoxical example. Bread is a main type of food, if the price of bread reduces, the purchase power of consumers will increase, they thus eat more meat while less bread. The price of bread reduces, yet the quantity demanded for it decreases. This paradox makes bread called a Giffen goods. Logically, Giffen goods doesn't have to be bread — it can be any goods. In other words, Giffen goods are inferior goods pushed to the extreme: the price reduction of a good leads to an increase in people's real income, and further to the decrease of the quantity demanded for the good. Logically this has nothing wrong.

Giffen goods are familiar to any freshmen that major in economics. They don't know — all economists have weirdly ignored either — that Giffen goods logically exist because we consider only the quantity demanded of each single individual and ignore the competition among them. Logically, Giffen goods cannot be traded on the market, used in back-door dealing, given and taken privately, exchanged in political deal, or allocated according to seniority. In other words, if Giffen goods can ever exist in a real world, that can only be Robinson's one-man world. Robinson's world doesn't have market or any other allocation related problems, yet Robinson has his needs, and need sacrifice as well. Because there is no allocation competition, Giffon goods can exist in this one-man world. However they cannot exist when there is social competition. That's to say, the competition among individuals eliminates Giffen goods. On the other hand, the twentieth-century masters of price theory, like Alchian, Stigler, Coase and etc., all reject the existence of GIffen goods. However, they cannot reject inferior goods. But rejecting one while keeping the other cannot be logically consistent. So I prefer my own handling to let competition eliminate Giffen goods. It will be further explained in Chapter 7, Section 1 of this volume. (That chapter is my own discovery, it rejects Marshall's scissors analysis, plain and clear, and one can easily see Giffen goods don't exist in social competition.)

(Translator: The “paradox” of GIffen goods, as well as inferior goods, originates not from the concept of utility, but from the special treatment of wealth and income. Wealth is nothing special but an economic good as well, and income is just part of one's wealth in a specific form. As an economic good, wealth has its substitution relationship with other economic goods, too, and one can choose whichever combination of wealth, beer and wine, which form a 3-dimensional surface. Once one wins a horse bet, or the price of bread reduces and leads to an increase in real income, as is in the Giffen example, the man just experiences an increase of his wealth. Whether this would lead to the decrease in the quantity demanded for beer or bread, just depends on the man's substitution preference in allocating the extra wealth.)

Convexity Postulate

Chapter 4, Section 5: Convexity Postulate

We can safely install another constraint to behaviors. That is, an indifference curve must curl inwards (concaving towards the lower left), like the bow weapon of Hua Rong the Little Li Guang, a fiction character in Water Margin, which "bends to a full moon". (Well, this is a joke, indifference curve doesn't have to curl that heavily.) This constraint (indifference curve neither is straight nor curls outwards) is called the convexity postulate, or the postulate of diminishing marginal rate of substitution.

Intention of the constraint is obvious. If utility stays unchanged (on the same indifference curve), the more A goods one has, the less willing he must be to substitute his B goods for more of A. This postulate is safe, if only the substitute happens on a same indifference curve. If the wealth or income of this man increases and he jumps to a higher indifference curve, his marginal rate of substitution will be totally changed. This is a great obstacle for the application of utility analysis to behavior prediction, and disables an important constraint to behaviors. Later we will get back to this.

Well, by the same indifference curve, the convexity postulate has a conclusion, which is not so useful. The conclusion says, if the price of a good decreases, the quantity demanded for this good on a same indifference curve must increase. That's because a price is always relative, when the price of a good A decreases it actually means the sacrifice of other goods needed for same amount of A reduces. In that way, the decrease in marginal rate of substitution would enlarge the quantity demanded for this price-lowered good.

The difficulty is, indifference curves and corresponding utilities are castles in the air, imagined by economists, and don't actually exist in reality. We cannot make sure whether one's choices would remain on the same indifference curve when the price of some good decreases. The logic reasoning for that is: when the price decreases, a consumer's real income would relatively increase, so he will jump to another higher indifference curve. One step further, when the marginal rate of substitution changes due to some other reason, what can we do?

Postulate of Substitution and Indifference Curve

Chapter 4, Section 4: Postulate of Substitution and Indifference Curve

In the first two chapters of this volume we have said, that to explain behaviors with a theory, the theory must install constraints to the behaviors. That individual maximizes his interest is a constraint, and with the concept of utility, that becomes one maximizes his utility. This constraint is a postulate and doesn't explain too many things. Asserting one maximizes his utility solely is tautology, and with the variation of constraints we can make predictions only when one economic good increases while all the others don't decrease.

The postulate of substitution adds another constraint, and widens the scope of explainable behaviors accordingly. The postulate says: everyone is willing to sacrifice any good he has for any other good. Do you agree or not? Are you willing to sacrifice your life for a bowl of fish ball noodles? This postulate says you are. If only the sacrifice is low enough and the gain is large enough.

When you cross a road to eat fish ball noodles, you are risking your life a little bit — the risk of a car accident is not zero. Like other fathers, I can sacrifice myself for my children — it's love. Yet because of work I don't have much time to stay with them — it's a substitution between love and livelihood.

Don't say that because you are principled, you'd never make a concession on matters of principle. Everyone has his own price, my soul can sell as well. The price is quite high, yet if you offer me a very big benefit while I need give up only a very minor principle, we can make a deal. This is substitution.

Due to everyone is willing to make substitutions, utility analysis thus creates the well know "dengyou quxian", or indifference curve, (normally translated into "wuchayi quxian", or no difference, in Chinese, which is neither elegant nor correct; "dengyou", or equally good, is my translation and gonna become classic). As one is willing to lose A while gaining B, we can find a curve for the two economic goods A and B, on which every point has a same utility. "Indifference" means same utility, and each point is indifferently preferable. Take A as the horizontal axis and B as the vertical, this curve must slope to the lower right, indicating one's indifferent substitution. The curve is a watershed, each point to the upper right of it has a utility higher than any on the curve, while the ones to its lower left go reversely.

Indifference curve enlarges the range of predictions. When there two economic goods, to be more preferable, it doesn't have to be A and B both increase, or A increases while B doesn't decrease: one increases while the other decreases can also be more preferable. There are an infinite number of indifference curves, each two of them don't intersect, and every upper right one has a higher utility number than any to its lower left. Under constraints, a man will choose the highest indifference curve he can reach.

Fisher's Contribution

Chapter 4, Section 3: Fisher's Contribution

Nowadays, the utility numbers economists use are mostly ordinal measure. Numbers of ordinal measure are not additive, but they can be ranked. Ranking is measuring. For an unadditive ranking, the margins between numbers are not comparable. 101 is greater than 99, and 99 is greater than 89. The former margin is 2, while the latter is 10, since the numbers are not cardinal measure, we cannot say the latter margin is five times larger.

Let's have some examples. In a Miss Hong Kong contest, the champion wins a score of 88, the runner-up 82, and the third place 79, then the ranking is settled. But we cannot say the margin between the champion and the runner-up is two times as large as that between the runner-up and the third place. Another example, when students take an exam, the teacher ranks them by scores. When I was studying in UCLA, one student asked the teacher how test scores were calculated. The teacher answered: "Test scores is just an arbitrary ranking, teachers that don't do this would be too stupid to teach in UCLA." The scores for essay questions are ordinal measure.

Ranking utilities with ordinal numbers doesn't have any logic problem. The assertion that someone takes A over B because the utility for A is larger, if relevant constraints properly handled, explains the behavior sufficiently. But when measuring utility with ordinal numbers, we know neither what the margin between A and B means, nor where a total utility for that man can be used. More than twenties years ago, the father of a Hong Kong middle school student called me, and said his son cannot answer the teacher's question about the use of total utility and thus failed an exam. The father asked for the answer, yet I asked in reply: "Does your son really not know the answer?" "No, he doesn't." "Good, your son actually knows more than his teacher!"

In 1892, I. Fisher (1867-1947), who later became the greatest economist of the twentieth century, published his doctoral dissertation, part of which is about utility theory. That's a genius book, and a key point in it is, to explain behaviors, cardinal ranking of utility is totally unnecessary, because at margin, cardinal ranking and ordinal ranking are of no difference, while for behavior explanation "margin" is sufficient. "Marginal" utility means the numerical change of utility brought by the increase or decrease of an item. When viewed at margin, neither addition into a total utility is necessary, nor comparison among different margins.

The idea that changes at margin suffice for behavior explanation originated from W. S. Jevons (1835-1882), and thrived due to Fisher's cherishing. In 1946 Stigler pointed out, if two products are produced through a single process, the average cost for each would be unable to know, yet the variation of marginal cost is knowable. To explain production behaviors, the information of average cost is unnecessary.

Later on when I was engaged in transaction cost research, I'd start only from changes at margin in any analysis. In the real world, transaction cost is not easy to measure. A viable means to explain behaviors is to see under different scenarios whether the transaction cost would go up or down. Change means "margin", and if there is no change, a behavior can never be explained. In dealing with transaction cost via changes at margin, it doesn't matter whether cardinal measure or ordinal measure is used. We cannot say cardinal measure is more accurate either, because accuracy here depends on the acceptance of observers, not the thoroughness of numbers.

Let me stress once again. Utility is just a free name for the ranking numbers of options, aiming at explaining a man's choices. This is what my teacher Alchian has said. Stigler has said: "Whether we assume one maximizes wealth, religious belief, elimination of love song singers, or his waistline, for rigorous demand theory it just makes no difference." R. H. Strotz has said: "Obviously, we don't have to find out whether the measurement of utility is in money, leisure time, octave, or inch, not to mention a psychological unit." These are all wisdom in the fifties of last century.

Utility is the Name of Numbers

Chapter 4, Section 2: Utility is the Name of Numbers

Generally speaking, to predict or explain behaviors/phenomena requires a measurement. To predict you'd take a right turn at a crossroad instead of a left one, is because turning right is faster, safer, or more comfortable, etc., which are all measurements. A measurement doesn't have to have many options, but at least two. To say A is bigger than B is a measurement, and that I assert under certain circumstance you'd choose the bigger over the smaller, is a prediction.

A measurement is ranking: ranked by big and small, by more and less, by heavy and light, etc. If the options for ranking are too plenty, A, B, C, D ... all used up but are still not enough, we then need numbers. Numbers are unlimited in amount. A measurement is thus defined as ranking with numbers. Yet these numbers have no content. When I say 17 and 29, you don't know what I am talking about. But if I say 29 pounds, you'd know it is the weight of some item, and also know 29 pounds is heavier than 17.

Because a selfish man maximizes his interest, we can use numbers to rank his options. If I assert under some circumstance this man would choose 29 over 17, you will certainly ask, what are exactly the 29 and 17?

Here right is the problem. I use numbers to rank your options, but the numbers don't have content, how does that happen? I can say the numbers you'd pick are in pounds, but "pound" means weight and that'd bring confusion. Anyway, I have to give a name to these ranking numbers, what shall I do? I therefore close my eyes, open a random page in dictionary, put down my finger on a word, reopen my eyes again and read it: utility. (Translator: Utility here corresponds to weight instead of pound.)

After more than one hundred years of nurture by countless scholars, at the time of mid-twentieth century, feasible definition of utility was simple: utility is the name of the numbers used in option ranking. It neither stands for happiness, nor enjoyment, nor welfare. Utility stands for option ranks, and as numbers are unlimited in amount, we let them come into play, and assert the option corresponding to a larger number is preferable, or vice versa, but never equally preferable.

"Utility" is an arbitrary name for the numbers of option ranking. It doesn't matter how big a number is, but what rank it takes: if the utility of a bigger number is set preferable over that of a smaller one, it cannot be reversed in the midway of analysis. This is a requirement by logic.

Roughly speaking, numbers have three applications, two of which are measurable. First, the non-measurable application is identification. If you go to a horse race and make a bet, there'd be a number for each horse, like 7, 3, etc. These numbers mean neither size nor speed, but are used only for identification. If you bet on the 7 and it wins, you can then have your prize.

The other two applications are about measurement. There are two types of measures because numbers can have two types of ranking. By one ranking, numbers can be added up, and that's called cardinal measure; while by the other, numbers can only be ranked but not added up, it's called ordinal measure.

A fish is 2 pounds and a chicken 3, with the two added up it's 5 pounds. So pound is cardinal. If you can't find an 8 feet rope, you can just add up a 3 feet and a 5. Foot is also cardinal. All cardinal measures can go through linear transformation. For instance: Fahrenheit degree of temperature is cardinal, and so is Celsius, thus with the Fahrenheit number at hand we can obtain the Celsius degree through a formula, securely. Pound and kilogram, or yard and meter, are all linearly transformable.

One difficulty for measuring utility is, utility is not always additive. The utility number for a pound of bread is 4, and that for an ounce of butter is 4 either, but when the two are eaten together, the utility number would be greater than 8. The utility for a cup of coffee is 4, and that of a cup of tea is 4 either, but when drunk together, the number of each cup would be less than 4. So when dealing with compliments like bread and butter, or substitutes like coffee and tea, additive utility would have insurmountable difficulties.

That said, economists once had devoted great energy to find a way so that utility can be cardinally measured. The most fabulous was the book cooperated by the twentieth century master of mathematics J. von Neumann (1903-1957) and economist O. Morgenstern (1902-1977), Theory of Games and Economic Behavior. In its second edition (1946), the authors pointed out, when there is risk, utility can be cardinally measured. Yet this cardinal measurement requires four assumptions, while two of them are problematic.

A Pathetic Development

Chapter 4: The Notion of Utility

Utility, a word frequently used by western economic scholars, is translated as "xiaoyong" (usefulness) in mainland China, while I think "gongyong" (worthiness) could be more appropriate. I've yielded to many other mainland translations, but this time I won't. The former translation "xiaoyong" is too real, and tends to make people feel there is really such a thing, which there is actually not. In China's cultural tradition,  there has never been such a concept of utility. As there is this cultural difference, one has the concept while the other doesn't, any translation of it can only be like blind men learn what an elephant is. Due to the same reason, some other concepts are almost untranslatable as well, like "cost", I don't think it's correct to be translated as "chengben" (expense), but I cannot come up with a better one either, so I just follow and yet express my attitude here that the translation is not so right.

Anyway, it's not so important for not having a perfect translation for "utility", because it had been more than a hundred years before western economic scholars made clear what the concept really means. With knowledge passed through generations, they thought they had understood, but actually not. It's not until the mid-twentieth century that the utility concept in economics receives an unambiguous definition. Yet as of today, many economic scholars still haven't got the correct definition. It can't be these scholars are too stupid to understand the concept, as many of them are indeed very smart. It's just they are unwilling: if they understand and agree the notion of utility detailed in this chapter, they'd lose their ambition to engineer any social improvement, and become nobodies like me.

Chapter 4, Section 1: A Pathetic Development

In 1789 and 1802, the English master of economic philosophy J. Bentham (1748-1832) originated the concept of utility, and influenced later generations vastly from then on. Bentham originally had three intentions. First, utility is an index of happiness or enjoyment. Second, everyone strives for a higher value of this index. The latter aspect led to the mathematization of selfishness, and after calculus was introduced into economics, utility functions flourished. Today they are still very popular in economics. Yet that's not because utility is indispensable in explanation, but because it makes mathematics applicable. Those skilled in math can thus have more showtimes.

Bentham's third intention was, when one's income increases, marginal utility of his income would decrease. He further made an assumption that everyone has a same version of income enjoyment, therefore the marginal income utility of a rich is low while that of a poor is high, the maximum welfare of the society would then be reached when all individuals have the same amount of income. This was the theoretical foundation of egalitarianism, and the predecessor of today's welfare economics.

Well, whether one's income increase would lead to a decrease of his marginal utility of income, is quite questionable. What economists all agree on today, is that utility indexes of different individuals are not comparable. The importance of one more dollar to a big rich doesn't have to be less than that to a street beggar. This only point would suffice to crush welfare economics. In 1950, P. Samuelson (1915-2009) pointed out in one profound paper, that no matter how much the total income of a society increase, as long as the income of some members (even only a single individual) has a decrease, economists would then be unable to affirm social welfare is improved.

Even Samuelson, the No. 1 figure of welfare economics, said like that, why are there still many practitioners of welfare economics today? I guess there two reasons. First, like previously mentioned, these economists think they are capable of engineering social improvements. Second, they need improve their own welfare: by advising the government in welfare engineering, they can have more income. In fact, the government loves to cut broad thongs of another's leather, sending taxpayers' money to economists: before the implementation of some policies that satisfy their own interests, government officials always need the words of corroboration from such scholars.

Scientifically speaking, the most important question on utility is Bentham's first intention: utility is an index of happiness. As the proverb goes: you are not a fish yourself, how can you know the happiness of it? How could you ever know whether I am happy or not, or whether I am more happier than yesterday? Leopards cannot change their spots, so are many economists, who always take themselves as capable as God. Today there are still people that view utility as an index.

In 1915, a self-taught Russian economist E. E. Slutsky (1880-1948) published — in Italian — an influential paper. After he passed, the paper was translated into English in 1952. One point of this great work was that, if we are going to explain human behaviors with a utility theory, then the concept of utility must be freed from subjective happiness or enjoyment. Mustn't it? To explain human behaviors, we need predict their choices, or under varied conditions how the choices would change. Whether one's choice is based on an increase of happiness, doesn't matter at all.

Since Bentham, participants in utility theory research almost included every important economists. Unfortunately, efforts of these countless geniuses earned only a history full of pathos. In 1950, G. J. Stigler (1911-1991) published a long paper titled The Development of Utility Theory to retrospect the history of utility thoughts over the past more than one hundred years. The paper was very knowledgeable, and also very graceful. In its conclusion Stigler could not help losing his temper: he thought economic scholars had had so little intention in theory validation, that all the efforts virtuosoes had payed in utility theory made nearly no contribution to our explanation of human behaviors!

I loved a paragraph of Stigler's conclusion in that work so much that in 1968 I had him write them down on a white paper, so that I can place it on my table as a motto of research. Today the ink has faded, but the scripture remains. I post it here so that the readers can appreciate the handwriting and keenness of this genius of the twentieth century. The words are as follow:

"The criterion of congruence with reality should have been sharpened — sharpened into the insistence that theories be examined for their implications for observable behavior. Not only were such implications not sought and tested，but there was a tendency，when there appeared to be a threat of an empirical test, to reformulate the theory to make the test ineffective. Economists did not anxiously seek the challenge of the facts." 

George J Stigler

Anyway, the theory of utility is still very popular today, so I have to spend some words to elaborate its key points.

In 1972 I published a paper about some phenomena like "blind marriage" and "child wife" in Chinese traditional marriage. In its last section I criticized the theory of utility heavily and deemed it totally useless. Economic Journal (Royal Economic Society) wanted to publish it but required me to reduce another five pages, so I simply removed the last section. After publication, two exerts wrote to me and blamed that I shouldn't have removed the section they thought the most important. Later the manuscript of this section cannot be found any more.

That I was against the theory of utility, was mainly because "utility" is only an imaginary concept by economists, a castle in the air, not fact, invisible and untouchable, so it's very difficult to derive refutable implications under this theory, and most would be only tautology.

At the time, R. H. Coase was on my side, while on the opposite side were three man I appreciated a lot: M. Friedman, G. Becker and my teacher A. A. Alchian. They opted to keep the theory of utility, as many economic goods — like friendship, reputation, family love, etc. — cannot be measured with money. As money cannot be used, they thought utility should come into play. In the following I will explain why I don't agree their point, but let me first show what the notion of utility that everyone agrees is.

The Scope of Economics

Chapter 3, Section 7: The Scope of Economics

Now that economics doesn't judge good or bad, what exactly does it do? Well, the scope of economics includes three parts.

First part, when constraints or game rules, e.g. definitions of rights, are known, we can predict what the victor criterion would be. Problems of this part are  complex and difficult, but with great efforts made the task can always be accomplished. In fact, that could be the easiest way to distinguish virtuosos and mediocrity of empirical economics.

Worldly affairs are like chess games, every one is new, so are the constraints of  economics, and no analysis can cover everything. Important relevant constraints must be identified and simplified. Yet what's "relevant" and what count as "important" shall not be at the analyzer's will, or else the conclusions of analysis can be easily manipulated. In other words, the choice of constraints must be restricted, while the restriction requires theoretical guidance. That's a deep question about methodology, we will discuss it when analyzing price regulation in Volume 3.

Second part, which are the easiest of economics, is when the criterion of competition is identified, economics can predict how people would behave, how resource would be used, and how the wealth or income would be allocated. As is said previously, different criteria would lead to different behaviors, and winners or losers (allocation of income) would shift accordingly. Housing allocation and queuing for purchase, etc., belong to this part.

As a matter of fact, all the meritorious results of more than two hundred years of western economics, except the recent forty years, are of this part. The partitioning into the two so-called categories of income distribution and resource allocation is a tradition of economics. Today's books of economics follow the tradition, yet the pity is they usually make it so wrong.

Traditional economics, the analysis of income distribution and resource allocation, are mostly based on market price as the victor criterion. This criterion only works under private property rights system. That's to say, although traditional economic analysis can explain the distribution of income and human behaviors, its scope is quite limited. Private property rights system is only part of the inexhaustible variety of game rules in this world. With orthodox textbooks of economics learnt, no matter how advanced they are, we can only explain a small part of all worldly affairs. Have textbooks well memorized and following a stereotype routine never ensures any little bit chance of accomplishment. Science must be creatively learnt and applied, even more so is economics.

Traditional analysis of economics are mostly based on the criterion of market price, thus limited in scope, but it doesn't mean the economic analysis with other victor criteria are insolvable. During the past forty years, the so-called new institutional economics has been trying to extend the basic principles of  economics to a variety of new victor criteria. Sadly the result is only a mess, because the practitioners of economics had recruited too many castle-in-the-air concepts that violate the "invisible is untestable" principle. Certainly, different competition criteria would mean different effects, but a same theoretical foundation can just be easily applied. If we identify what's the criterion of competition, the prediction of income distribution and resource allocation would be really straightforward. In other words, once relevant game rules (e.g. constraints) made clear and the criterion of competition pinpointed, it would only take a couple of days to have all competition behaviors sorted out, as precisely as is in any natural science.

The third part in the scope of economics is the hardest. It's to explain how the game rules come into being. Why is there shared property rights system in this world? Why is there rent regulation in Hong Kong? Since game rules are linked directly with competition criteria, this part of economics has to explain how the competition criteria are determined as well. Why are the teacher housing of HKU allocated by points? Why was seniority used in past China?

How did different systems of property rights come into being? Why do laws change with time and location? Why are Hong Kong's legislative procedures different from those in Taiwan? What is a nation? Why do we need nations? Why is there constitution in some nations while not in the others? Why did people's communes occur in past China? All of these are profound questions.

Oddly enough, some economic problems profound to economists may seem very plain in some laymen's eyes. The latter likes to brag on these problems eloquently, yet their "explanation" indeed has nothing to do with science. If members of the Legislative Council of Hong Kong are asked, "why is the legislation passed?", they'd usually sprout eloquent speeches. But when we carefully examine their "theories", we'll reach one of the four only results: (1) what they say is ad hoc theory, which has no general applicability; (2) what they say is tautology and has no information; (3) what they say is their personal value judgment that has nothing to do with science; (4) what they say is only nonsense.

F. Hayek once spent great efforts to explain problems of this part of economics, but with only little success. Over the last forty years, the theory of state has been a hot topic, and many scholars, including J. Buchanan, G. Stigler, G. Becker, D. North, H. Demsetz, Y. Barzel, etc., were involved, yet no major achievement has ever been scored. Certainly, on other topics they did quite well. I once created a theory of state, which I feel satisfactory, in my booklet Will China Go Capitalist, however only Coase and Barzel treasured it. Published in 1982, this theory accurately predicted the reform that'd happen in China. Nevertheless, for myself, another work China's Economic System I published in 2008 is actually more satisfying.

Economic Explanations is a summation of fifty years' gains the author has had in a learning, and the most difficult third part of economics talked here is all the author's research focus after he turned forty-five, which has been twenty years so far. The Volume 3 Choice of Systems written eight years ago was right for this part, yet looked back today many developments in it were quite unsatisfactory. Enlightened by China's reform, I have had many improvements in related thoughts. Hope this time I can be lucky enough and successfully take this third part.

Economic Analysis and Value Judgment

Chapter 3, Section 6: Economic Analysis and Value Judgment

As is said, the criteria of competitions determine the economic operation of a society. Among all the discussions on "criteria", some belong to economic analysis, while the others are actually about subjective or ethic problems, and thus have nothing to do with objective analysis. The two must be clearly distinguished.

As we all know, under different victor criteria, the winners or losers would usually shift. Therefore, some people prefer one criterion, while some others prefer another. Such preferences fit into the scope of economics. Take examination as an example, some students prefer essay questions as they are good at argument, while some others require multiple choice questions so they have a better chance of winning. All individual choice behaviors are the objects of economic analysis.

Yet which criterion is better, or how a criterion benefits social welfare, are problems of ethics or value judgment, and irrelevant to objective analysis. For example, as I've stated, taking market price as the victor criterion doesn't waste, because that would lead to increased production, while the other criteria all have certain level of waste. However, I never say increased production is good or waste bad. What's good or bad can only be decided by personal value judgment, or only God knows. (Translator: The distinction is fairly easy: ethics or value judgment seeks a unified standard of "better", a "better" that's gonna apply to at least one more person besides oneself, while analysis of economics doesn't.)

Previously the people's communes of China led Chinese people to the edge of starvation, why was it so is a problem for economic analysis, but whether living on the edge of starvation is good or bad, is then a subjective judgment. Economics can explain human behaviors, and can inform us under which constraints people would become living on the edge of starvation, but it doesn't judge right or wrong. By "no judgment", I mean economics doesn't do that, and don't mean economists don't do that. Never forget that, economists are also human and thus have their own value judgment. If I say hunger and cold is bad, that's a subjective assertion, from the standpoint of a human, instead of objective economic analysis. I certainly have the right to make such a subjective judgment, as I have a human's rights, but this right never requires any training in economics.

I can express my value judgment, and the others can express theirs as well, but whose is better, only God knows. Expression of value judgment doesn't require any prior training of analysis. You think blue is good-looking, while I say red, then who can make a decision that satisfies both of us?  You deem government's support of education good, while I think it's bad, then we aren't gonna be able to reach any conclusion even after hundreds of years of argument. That's because the views of good or bad, love or hate, cannot be objectively agreed upon via scientific analysis.

If I say hunger and cold is not good but bad, many would agree. That's just because most (almost all) of us don't like themselves to be in hunger and cold. People agree because they have the same value judgment, instead of because there exists an objective analysis for that. Economics can explain why people would be in hunger and cold, or with the support from government what would happen to education, but it never judges good or wrong.

As is mentioned, economists are also human and thus have their value judgments. Yet, when doing analysis, they may intentionally or unintentionally bring in their value expressions about certain effect is good or bad. Objective analysis and subjective judgment can appear together. It's no big deal, although sometimes the readers or listeners may get confused. What's really important is, people dealing with economic analysis must separate subjective and objective distinctly, and never allow subjective judgment interfere with objective analysis. That's to say, if an economist twists his analysis intentionally or unintentionally because he deems government  support to education good, so that the analysis breaks away from logical norms, then that'd be an inexcusable mistake in science.

Sometimes economists may haven't say anything about good or bad, yet outsiders think they have. For instance, I've said market price can promote production, and many readers think I deem market price as a good criterion, which I have never said. The readers think I did, because themselves think production increase is good. Of course, when writing for newspapers, to avoid dullness, I sometimes make my judgments of good or bad. Nevertheless the focus of this book is objective economic explanation.

Some readers think I believe in and have special preference to market. I do trust in the capabilities of market, while I also know there are things that the market is incapable of. Yet my personal value judgment is against market, and I hate communist system as well, because I can hardly stand out under either of the two. What I really prefer, is to allocate social wealth according to study and exams, as I am really distinguished under any exam criterion. It's really sad, that nowhere of this world allocates wealth or beauties via exams. (Only God knows, the imperial examination system in old China did effect wealth allocation, but I guess I shall never have my chance to win!)

Criteria of Competitions

Chapter 3, Section 5: Criteria of Competitions

In an athletic game, it's the running speed that decides who wins. So speed is the victor criterion. But if the game has no rules to define what behaviors are prohibited, the criterion of speed would no longer function. Similarly, without game rules, the weight criterion in weightlifting wouldn't function as well. Chess games are won by intelligence; billiards are won by vision, techniques and hand control — all these criteria are guaranteed by respective game rules.

So is it for economic competitions. In a free market, the one offering the highest price wins, so price becomes the victor criterion. The game rules that give rise to this criterion are the private property rights system, which is the core of Coase and Alchian's thoughts.

For a long time, price analysis in economics had focused on how price is determined. Once the concept of price came into Alchian's hands, it gained a new life. He asserted: "what a price determines is far more important than how the price is determined!" This one sentence suffices to advance our knowledge of the world. Price is a victor criterion, while private property rights system is the set of game rules that lead to this criterion. That Coase and Alchian are honored as the founders of property rights economics, is because each has said some alike enlightening words.

Game rules and victor criteria are directly connected: the former determines the latter, and the latter determines the economic operation of a society. An interesting question is, was the birth of some game rules due to people's need of a certain criterion, or did people's need of certain game rules inevitably lead to the emergence of a victor criterion? At first sight, it's hard to tell which came earlier.

I think first came a criterion and then the game rules. Why? It's because a victor criterion settles the problem people need to solve via competition, while the game rules only assist the functioning of the criterion. Speed is the core of an athletic game, and the rules of this game only assist in judging who is really faster. School's score criterion of examinations is used to verify whether the students have put in efforts in their study, while the exam rules just fairly ensure the one with better knowledge can win. Price no only decides the victor, but also implies the one with higher productivity wins, while the private property rights system plays only an auxiliary role. You students shall be able to have a better understanding of this relationship after reading my analysis of rent dissipation in Volume 3. (Translator: It's fairly easy to understand that the price criterion came earlier. Exchange can occur without any property rights system, because on one hand both participants would benefit, and on the other hand the characteristic of information serves as a protection when there is no such from a law system. For example, you have something useful and hide it, then it's nearly impossible for the others to know you have it if you don't signal them, not to mention to know where it's hidden. With the assistance of a property rights system, exchanges just occur more frequently.)

As mentioned above, victor criteria determine the economic operation of a society. On one hand, the distribution of wealth or income of social members are decided by competition criteria. Criteria have many types, and under different criteria, the chance to win for a same person varies. For the people that are good at business running or goods production, the victor criterion of private property rights is the most helpful. For some others that have superb political tactics, non-private property system suits them the best. There are still some others that don't know how to cope with the operation of a frequent-changing market but can work honestly and industriously, then seniority would be the top criterion.

On the other hand, because victor criteria decide people's income and enjoyment, under different criteria their behaviors would change accordingly. Take price as an example. To gain profit in a market, one has to work hard, or invent new products, or formulate efficient management, or search for information that reduces cost, etc. But without the price criterion and incomes are allocated by rationing, competition participants would then choose "back-door dealings", or play political tactics, or try to become an official, etc.

Here the adage "criteria determine the operation of social economy" can be illustrated by two real cases on housing allocation in Hong Kong. As is known to all, the free market of housing properties in Hong Kong takes price as its victor criterion. Those that can and are willing to offer high enough a price or rent, can purchase or rent the housing they like for personal use. No matter how old, how beautiful, how skilled in political tactics, or how learned one is, he can't take the benefit if not paying the necessary price.

But within the University of Hong Kong (HKU), teacher housing is allocated according to points. Being a department chairman is 6 points, being married is 6 points, having one child is 6 points, having two is 12 points, one year of working is 2 points and eight years would then be 16 points. The total points is the criterion used to determine the order of housing allocation and the size allocated. It doesn't matter how learned a teacher is or what level his research has achieved. No enough points, no chance of winning an allocation.

As a matter of fact, the point criterion used for housing allocation in the University of Hong Kong is very close to that used for allocating housing to cadres at the early stage of China's reform, they are almost identical. The reason is, the constraints HKU has and China's state-owned property system share many similarities. The housing properties of HKU are not private but public, or government-owned. From the perspective of property rights, the mechanism employed by HKU actually belongs to a "shared property rights" system, in which the allocation of housing has nothing to do with market price. The difference between HKU and past mainland China is that the "shared property rights" system in HKU only works for the matters of the university, while that of past mainland China was generalized and spread to the entire nation.

From above two cases about the housing allocations in the market and HKU, we can easily see, under different victor criteria the winners are different. A man with sharp eyes in business wouldn't make any difference at HKU, while one with many children wouldn't enjoy any priority in the market. If we go deeper, we can know, under different criteria people's behaviors differ, therefore the efficiency of production would be different as well. The criterion used by HKU in housing allocation encourages more children, early marriage, and long term service to the university. The higher price criterion, instead, encourages hardworking, cost reduction, and saving, etc.

In economics the concept "waste" is not simple. Only until Volume 2 will we have a deep discussion about it. Here I only introduce the waste concept that appears in common books but is actually not quite right. Generally speaking, waste means there are other approaches, or allocations of resource usage,  that can increase the wealth or income of a society, but due to certain reasons these approaches haven't been taken.

According to the above definition, among all countless competition criteria, only one has no waste. This only one is market price. Several examples can illustrate the point. Queuing up to make purchase, which takes first-come first-served as criterion,  need pay the cost of time. As the time is used for standing and waiting instead of production, that generates no benefit for anybody, so the value of the time is wasted.

Another example, let's get back to the point criterion for HKU's housing allocation mentioned above: a teacher at HKU can get more points by giving birth to more children or teaching longer. Then at some hesitation point (so-called "marginal"), to give birth to more children or to seek an alternative employment, would be decided by the consideration of earning better housing points. If someone doesn't plan to have that many children but gives birth to them as well, that's a waste, because the housing points doesn't mean anything about product value, yet the decisions of giving birth to more children are right "coerced" by increasing his points.

Using age as a competition criterion would encourage people to misrepresent their ages, even that costs a lot of money and energy, or to idle their time away and crave for a speeded aging. In a society that strong prey on weak, force is the victor criterion and thus investments in weaponry are strongly encouraged. Many years ago, gold mines were discovered in frozen Alaska, and a game rule was set up among competitors that the one winning the speed contest to a gold mine, would be entitled the privilege to mine gold for a day at right that gold mine. Because of the rule, people poured money on their sled dogs to make them as strong as possible. All these behaviors are wasteful.

The only unwasteful criterion of competition is, market price. That higher price wins is the only criterion that makes people work harder to exchange for what they need. To work harder for money means a better chance of winning a competition, while this additional work is beneficial to the society. So market price doesn't lead to waste.

All above "waste" opinions were deemed by me since the early 70s as rent dissipations, because characteristically they are the same as the rent dissipation of fishing on high seas. In fact, when writing the Theory of Share Tenancy in 1967, I had already had a similar idea in Chapter 6, Section 4. I've spent about forty years on these complex, important, and interesting analyses, and will have them detailed in Volume 3.

Game Rules and Property Rights Systems

Chapter 3, Section 4: Game Rules and Property Rights Systems

Like any sports, the competition aroused by scarcity also has its game rules. No game rules, no way to judge who wins. No winner, then no need to compete. Athletics has rules, so does tennis. Without the rules, victory or defeat cannot be decided. Even in the competition that strong prey on weak, there is a rule that winner lives and loser dies.

From the perspective of economics, the game rules for daily man vs. man competitions are laws, disciplines, customs, and etc. Just like the ones in sports games, these rules regulate and prohibit participants' certain behaviors during competition. That's to say, in social economic competitions, laws, disciplines, or customs, whichever it is has a mandatory method to define individuals' rights. Such definitions of rights form the property rights systems. In Volume 3 I will explain that, an arrangement to constrain competition is actually a contract arrangement, which is another angle to view the property rights systems.

(Translator: The ultimate game rule for competition is always violence. Although individuals have almost the same natural capabilities, the formation of collectives, or societies, brings about every possibility. Two shall triumph one, yet three may lose to two. With the development of motion and communication technologies, the distribution of violence converges towards monopolization, where individual's violence is negligible before the monopoly, no matter it's a democratic legal system or an autocratic military government. Soft violences, like credit discrimination or cooperated isolation that appears in disciplines or customs, rely on the violence monopoly as well, for example, a bad credited person cannot revenge the people that don't trust him, as he would get punished by a legal system. Upcoming discussions are all based on a monopolized utilization of violence.)

The systems of property rights are the game rules for competition, and a type of constraints on competitive behaviors as well. If discriminated cautiously, these rules are actually quite different. Private property rights is just one of it. It's even possible to classify all the systems into several categories and systematically analyze how the variation of each category would affect human behaviors. As are the contents of institutional economics, they will be detailed in Volume 3.

The word "property" is not simple. From the perspective of economics, property is economic good with human competition, which is slightly different from its legal definition. Legally, property usually means assets (especially lands and buildings); yet in economics, other than assets, it includes consumables as well. What consumables have in common with lands and buildings, is that they both are scarce and competitive.

Alchian made it perfectly that "property", competition, and scarcity, are indeed synonymous. Readers must spend more time pondering on this "synonymy" until they fully understand in our society competition is ubiquitous. Without grasping this general concept of competition, one can never achieve anything in economics.

Essence of Competition

Chapter 3, Section 3: Essence of Competition

The desert island that Robinson once lived on is a one-man world, there competition doesn't exist. Although there'd be animals to compete with Robinson for food, there is no man vs. man competition there. In economics competition means the one between man and man — all postulates of economics are for man and most behaviors that economics explains are competition behaviors.

In Robinson's one-man world, there exist free goods, and economic goods as well. To get more of an economic good, Robinson must pay certain sacrifice. To eat one more fish, he need cut rest time; to collect more wood for fire, he need reduce apple planting; eating more wheat this year means eating less next year. In a word, on the island, Robinson faces short supply, not everything is free good and sacrifice is required, therefore like us he need choose among options. The only difference is: there is no man vs. man competition for Robinson.

In that one-man world, economics is fairly easy. We can use economics to explain Robinson's behaviors, and the whole explanation, if simplified, won't last more than two or three hours — for a thorough analysis two or three days would be surely enough. Just imagine, in Robinson's one-man world, there is no market, no price, no currency, inflation, or unemployment, and no law, police, or politics, not to mention arms, intermediary, contract or institution. Without these, economics can't be any deeper.

So the complexity and profundity of economics is all because one more man entered the one-man world. When there are two or more people in a world, they become a society — this is the clearest definition of "society". The joys of economics all stem from the existence of such "societies". We could even say: more than ninety nine percent of the complexity of economics is because we live in a world of more than one man.

Let's keep moving our reasoning on. An economic good must be better more than less. In a society, when one wants more of the good, others may want more as well. When monks are many and the gruel is meager, competition is inevitable. Competition is defined as more than one person demands an economic good. In the society we now live in, such goods are everywhere. Free goods, like fresh air, do exist, but the number is getting fewer and fewer.

In a society, economic good without competition is not easy to find. In principle, in a society an economic good doesn't have to be under competition, but examples are so few that one may need rack his brain to identify just one or two. More than sixty years ago I was attending the Wan Chai College in Hong Kong, fellow students then liked to fetch a cinema-issued brochure, called "show bridge", that briefed the story on show, when they entered a cinema. Because many students collected the brochures enthusiastically, old (out of date) "show bridges" became scarce and started to have price, some hard to get were even traded for several Hong Kong dollars. At the time several dollars meant one week's pocket money for me. Old "show bridges" became an economic good and had competition. After several years, the hobbies for collecting "show bridges" vanished, and students started to dislike and throw them away. But there was this student named Ting who loved "show bridges" so heavily that he didn't stop his collection. So for this weird student, old "show bridges" were an economic good (better more than less) but had no competition. This is one rare case that I know when an economic good has no competition. Time changes, today cinemas in Hong Kong don't issue such "show bridges" any more. I haven't met the student named Ting for fifty years, don't know how his piles of "show bridges" would eventually become.

In a society, nearly every economic good has competition. And the competition keeps going day after day. As everyone of us has been having competitions from morning to night and from young to old, we might be so accustomed that we don't even notice they are actually everywhere. The breakfast we eat is won through competition, as when one eats more someone else must eat less. In each competition someone "gains" and the other "loses" (Translator: quantitatively). Breakfast is so, lunch is, the bed for sleeping is, taking transit bus, going to school, sunbathing on the beach, watching TV at home, etc., all of them are!

So to speak, in a society we can hardly find a behavior without competition behind. "No competition", from the viewpoint of strict economics, can rarely be justified. Some unintelligible economic textbooks, when talking about monopoly and patent right, assert there'd be no competition. Yet the real fact is, monopoly and patent right only suppress one type of competition, some other type is surely enhanced at the same time, though. For example, people may strive for monopoly or patent right during competition, yet in a monopolized (or patented) market, they can still compete through similar or substitutable products for profit.

In a society without market, competitions are all around either, and they just take different forms. That strong prey on weak is competition, power struggle is, back-door dealing, seniority ranking, stratum privileges, etc., they all are forms of competition. The principle is quite clear: any time more than one person demands the same economic good, there exists competition.

What is Scarcity

Chapter 3, Section 2: What is Scarcity

"Better more than less" is how economic goods are defined, and that defines "scarcity" as well. That's saying, all economic goods are scarce and insufficient. What then does "insufficient" mean? If the breeze from a river and bright moon in mountains are, like Su Dongpo the Poet said, inexhaustible, they are sufficient (Translator: the poet lived almost 1000 years ago). In that way, they can only be free goods — although in today's real world breezes and bright moon are no longer easy to get and thus have become economic goods. Strictly speaking, "insufficiency" doesn't have to be linked with the quantity supplied. For example, there are more good eggs than bad ones, yet good ones are insufficient and bad ones are excessive. Good eggs are greatly needed and thus insufficient; bad ones are disliked by everyone, so even a few are already excessive.

If a good is not demanded, there'd be no "better some than none" for it; and if supply of the good is not insufficient, there'd be no "better more than less". So "scarcity" happens only when a good is demanded and its supply insufficient. When demand increases, more supply (still limited) remains scarce; if demand decreases, limited supply may become abundant. That's to say, scarcity is determined relative to demand.

A scarce item — an economic good — is something whose supply cannot meet people's demand. So the item is better more than less. As it's better more than less, if one wants more of it, he must pay a certain sacrifice. If nobody is willing to pay a sacrifice for more of the item, it cannot be counted better more than less, which is logically inarguable. Therefore, any item, that there is someone willing to pay a sacrifice for more of it, is scarce and insufficient, thus an economic good. On the market, the sacrifice we need pay is price. So we can conclude anything that has a price is scarce and insufficient. In some societies — like extreme communist society — there is no such a market and thus no price for a good, but sacrifice doesn't vanish. Therefore we have another assertion: an item without a price can possibly be economic good as well, and scarce of course — as is scarce (people want more), some sacrifice is inevitable.

Definition of Goods

Chapter 3: Scarcity and Competition

To explain behaviors with a theory, the theory must install constraints to those behaviors — this is a basic principle. The methods of economic explanation are the same as those of any other empirical science: on one hand, we have some general postulates, axioms or laws; on the other hand, we install test conditions or circumstances that constrain behaviors. With both of them, we can imply under certain conditions how people would behave; and when the conditions vary, the behaviors change as well. To be refutable, the implication must be definite — if not definite, how can it be "wrong" or refuted? When someone has these constraints well mastered, the applications of them would be at his will, and the implications can be stunningly accurate.

In Chapter 2 we talked about two postulates: (1) any behavior of a individual is by his choice, and the choice is predictable; (2) under constraints every individual always maximizes his self-interest. Other than these, we have some other constraining postulates and will analyze them in Chapter 4 and 5. At this point we need interrupt the topic, as scarcity and competition, two indispensable concepts in economics, require explanation first.

Chapter 3, Section 1: Definition of Goods

The word "goods" has many meanings. In addition to be interpreted as product or commodity, it can represent service, friendship, reputation, air, cleanness, serenity, lover, love, and etc as well. Everything better some than none, no matter tangible or not, is a good — "better some than none" is the economics definition of goods. From each individual's point of view, biological children, breeze from a river, or bright moon in mountains, are all "better some than none"; beautiful face, credible reputation, pleasant voice, sweet memory, ability of thinking, etc., are all goods.

Goods have two categories: one is economic goods; and the other is free

goods. In all the goods that are defined as better some than none, a major part are better more than less. "Better more than less" is how economic goods are defined. In such a definition, "better" shall be objective. Suppose we split 250 grams of gold into two shares, one 100 grams and the other 150 grams, and let people choose, if the 150 gram share is chosen, gold is then an economic good. The chosen share of a comparison always means better, and it doesn't matter whether the share is really beneficial or not. Therefore, here "better" has nothing to do with subjective or value judgment.

Better more than less are economic goods and they are countless in this world. Gold and silver, grapes and wine, abalones and shark fins, fruits and vegetables, clothings, foods, houses and cars, tours and rests, family love, etc., are all economic goods, as each meets better more than less.

Among all goods, a minor part are better some than none but not better more than less, as the supply of them exceeds demand, and any addition makes no use. Goods like this are not plenty, among them air is the most frequently cited one. In areas where air is freshing, the supply of air is unlimited, and nobody would strive for more than needed. Although air is necessary for man, it's only better some than none and not better more than less. Air is therefore a free good instead of a economic good. But when an area is crowded and the air there is stale, the need of more fresh air becomes realistic. Under this circumstance, fresh air is no longer a free good, it's now an economic good.

Conclusion on Selfishness

Chapter 2, Section 5: Conclusion on Selfishness

Although there are reasons that we shall believe selfish is human nature and unmodifiable, yet from the perspective of economic science this really doesn't matter. What's important is selfishness is treated as a postulate and we shall not argue on that starting point. Whether such a treatment is viable in explaining human behaviors, depends on whether the refutable implications derived under this constraint together with some others can pass the tests against facts. In this game of scientific dialectics, we cannot deem human selfish sometimes while not the other times, because that would mean we cannot derive any refutable implications.

Handled in this way, the postulate of selfishness does exhibit amazing explanation power. Probably in the future some genius may propose another one that replaces selfishness but functions better. As of today we haven't had such a thing, so the postulate of selfishness still has to be sticked to. This is not stubborn, it's just some rule of scientific methodology that we need follow.

If human nature is selfish (yes or no only God knows) and can't change, then should any ism be based on human selfishness can be modified, its system and policies would definitely fail. It's the experience of past China. Nowadays in this world, believers of such a selflessness become fewer and fewer, yet they still usually get exploited by some selfish guys for strengthening the latter's power and interest.

There's another important question, which is: if human's selfish nature could be modified, and the modifier omnipotent, what would he change human into? To say that nature modifiable doesn't tell us what man should be. Like a melon and cabbage? Like a computer? Or Frankenstein? I don't know what the readers would think of it. I just intuitively feel that a man as selfless as an angel would actually look more frightening than a selfish one.

In Chinese cultural tradition, the word "private" ("si" in Chinese) never means anything good: to carry something and escape privately (xie dai si tao), to give and take privately (si xiang shou shou), to seek private interest only (zi si zi li), etc., are all belittling usage of "private". After thirty years of reform and open-up, great progresses have been achieved in mainland China, yet private enterprises are intentionally called "citizen" enterprises, where the usage of "private" is avoided. How about in the western world? There "private" is respected. Why there is such a big difference between the two is elusive to me. For the translation of "private" into Chinese, by no means can I find any other except for "si". As is said, the selfishness here only means "to seek maximum private interest under certain constraints", which, as a postulate, has nothing to do with personal value at all.

Human's Selfish Nature

Chapter 2, Section 4: Human's Selfish Nature

From the perspective of history of economic thoughts, "selfishness" became a postulate only after the rise of neoclassical economics in the late nineteen century. In this newly emerged field, wide application of calculus from mathematics gave birth to marginal analysis, and made the concepts of maximization and minimization well accepted. That human act to fulfill selfish desires then became the postulate "under constraints individual maximizes self-interest" — or minimizes cost. The simple call of "selfish" is just a convenient saying.

After the rise of neoclassical economics, this branch of learning about human behaviors became scientific and professionals in the field started to view "selfishness" as an objective postulate. After that, whether human nature is really selfish or not doesn't matter any more. Of course, today many economic scholars still don't discriminate personal value and scientific dialectics very well, and confuse emotion and analysis heavily. On the other hand, connection of personal value or subjective judgment with objective analysis can sometimes perfect economics stunningly. Virtuosos of classical economics such as A. Smith, D. Ricardo and J. S. Mill had such  simple and sincere a personal value that's worth being admired and followed.

So it's correct, that the scientific postulate of "selfishness" we are using today came from the subjective judgments of past worthies. In Smith's classic Wealth of Nations published in 1776, the two paragraphs on selfish behaviors and market operation are the most popularly quoted sayings in economics. I have read them again and again, every time I ruminate I can gain new enlightenment and feel the heaviness within. He wrote: 

"Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favor, and shew them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher the brewer, or the baker that we expect our dinner, but from their regard to their own interest ...

"Every individual, therefore, endeavors as much as he can, to employ his capital in the support of self-interest maybe of the greatest value. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security and his own gain; and he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it."

After years of digestion of Wealth of Nations, I think Smith's view on "selfish" requires supplementation from two aspects. First, though Smith correctly pointed out selfish can promote effectually the public interest, he overlooked the harm that selfish can as well bring to the society. The latter plays importantly in the problems of transaction cost and property right, which have been the focus of my research. Philosophically, emphasis on the harm is the main difference between my Economic Explanations and the Wealth of Nations, so to say. However, my major conclusions, instead of discrediting Mr. Smith, have strongly reinforced him. Nevertheless, as I have a better understanding of selfishness, my explanations on behaviors shall be superior.

Second, Smith failed to indicate selfish is human nature. In his view, selfish is compelled: it's not someone desired, people just have to be selfish. This "survival of the fittest" viewpoint — many problems in Wealth of Nations were viewed in this way — subsequently influenced C. Darwin's (1809-1882) shattering work, On the Origin of Species.

My teacher Alchian published an important paper, Uncertainty, Evolution and Economic Theory, in 1950 and it ignited a massive debate on scientific methodologies that spanned for nearly two decades. The "idiots and gas stations" example I gave in Chapter 1, Section 4 was inspired by that paper.

Alchian's view shared some similarity with Smith's, but the former came much fiercer. Smith meant selfish is for survival; Alchian asserted it doesn't matter whether idiots are selfish or not, because after elimination the behaviors of left idiots inevitably accord with those when they are. (Translator: Alchian's assertion must be based on there is at least one selfish individual in the society. In fact, his result was just extrapolated from the dynamic view point of a society as an interaction system, where the selfishness of selfish people, if not all, is a sufficient driving force.)

In 1976, biologist R. Dawkins published The Sellish Gene. In that book he cited various examples and proved that selfish is innate in animals, inherited and unchangeable. The book gave rise to a new branch of learning — bioeconomics. Another teacher, J. Hirshleifer, of mine is an advocate of this new learning. More than a decade ago he wrote to me and said the learning was gonna have a bright future.

To be concluded, there are four views in "selfish". Smith thought it's compelled; Alchian always took selfish as a postulate, though, he asserted idiots would bring the same result; Dawkins took it inherited. I don't have any invention about selfishness myself, and just think a theory the simpler the better. My choice is to view selfish as a postulate of constrained maximization, a tradition from neoclassical economics. Once constraints are properly handled, explanation power won't be less.

Individual is Selfish

Chapter 2, Section 3: Individual is Selfish

That individual makes predictable choices — the first postulate of economics — is already a constraint. But it's not enough, and we need install other important ones as well. Here a second postulate is: any behavior of a individual is selfish. That's saying, under constraints, the individual acts to maximize his interest. No matter it's hard-working or rest, cheating or donation ... they are all selfish.

 As a postulate, the constraint is not arguable, and whether human nature is selfish or not is irrelevant: what's really important is not what human really are (that's a question for psychology, physiology or philosophy), but what we assume they are. Then here comes a problem, if we assert cheating, donation ... and so on are all selfish behaviors, is there anything that cannot be explained by "selfish"? The postulate comes as a constraint, but in the end it constrains nothing, how can it be justified? A good question. And the answer is: if we assert at will any behavior as selfish, like a tautology that cannot be wrong, the postulate would become empty and useless; but if we can install more constraints to indicate the circumstances under which an individual would make a selfish decision, and the variations of these constraints lead to inevitable variation of the selfish behavior, then there'd be a whole new story.

For instance, donation or help without a reason has nothing to do with selfishness. But under certain constraints, the cost of a donation is lower or its profit is higher, the actions of donation would increase. Then the postulate of selfishness comes into play. Here I can list some examples. Twenty years ago, Deng Pufang, the son of Deng Xiaoping, visited Hong Kong and raised a donation of 50 million Hong Kong dollars (he was disabled). Apparently my son doesn't have such a capability. If the donors donate just for benevolence, let's put my son's problem aside first, why did they make the donations so serious instead of mailing the checks quietly to a charity? There do be anonymous donors. But why donation would increase when there is a tax deduction for it? Where does sympathy come from? Why do people believe "good deeds will be rewarded"?

Under what constraints would people believe karmas or speak of benevolence, righteousness and virtue? Under what conditions would people have greater sympathy? And when would people be generous to ear fame? I really appreciate the generosity of Shao Yifu and alike in educations — naming a donated university building "Shao Yifu" is deserving and appropriate. To say Mr. Shao's donations were based on his own interest is not degrading him at all; if I were equally rich, I would never be that generous. If we gave up the postulate of selfishness, economics would have no other means to explain Mr. Shao's donations to universities is by choice instead of by chance. No behavior is random; donation is no exception.

And if we allow for exceptions, then any unexplainable phenomena can be attributed, and there'd be no longer irrefutable economic theories. In that way, the whole structure of economics would fail and collapse.

What's really difficult, is not whether the postulate is right or wrong, but how we explain selfishness leads to both cheating and donation under different constraints. As is said in Chapter 1, the examination and definition of constraints is the most demanding job in economics. A lot of human behaviors still have not had satisfactory explanations even today (this is why economics so interesting; a science that has answered all its questions is doomed), and that's mainly because we haven't had enough understanding of their constraints.

(Translator: Selfishness equals maximization of self-interest. In fact, since individual decides, which comes as the first postulate of economics, there can only be two options for him in any behavior: minimization, or maximization. Any other point between the two extremes cannot be deemed a decision, because it means random: given other things being equal, how can an individual acquire 6/7 of the maximum one time and 4/7 another time? Is there any reason that 6/7, if not the maximum or minimum, is superior over 4/7? Minimum, though, is too trivial to be viable, because that implies a breakdown. Therefore, that individual maximizes is actually equivalent to individual decides.)

Theory Must Install Constraints

Chapter 2, Section 2: Theory Must Install Constraints

Don't forget, a theory with explanation power must be refutable, or else it'd be of no use at all. What's equally important, to make predictions for a behavior, science must install constrains. Without constraints, the behavior can modify from time to time, like unsteady wind, and that makes no prediction wrong and the theory irrefutable.

A behavior must have constraints like under which circumstance it goes left instead of right; only in this way can the behavior be explained. Of course, when predicted to go left, the behavior may go right. So a theory that explains is possible to be refuted, but hasn't yet been. This has been explained in Chapter 1. More constraints usually means more accurate predictions, but that widens the chance a theory may get refuted as well. So science is an adventure game. The more constraints a theory has over a behavior, the better, but it shall never step into the realm of refutation. Only virtuosos of science can make assumptions boldly but weigh them cautiously, and by that way push the constraints to the safety limit that the theory won't get refuted.

Individual Makes Decisions

Chapter 2: Selfishness

Any debate must have a starting point, science is no exception. If we are still arguing the starting point, then science can do nothing. So in the development of science, everyone involved must obey a self-evident rule: once something has been specified as a postulate or axiom, people won't argue over that any longer. It's not saying all have to agree sincerely on these postulates or axioms. To agree or not to agree on them, it's not important, what's really important is to agree not to argue on the starting points. The true principle for scientific dialectic is: "Don't argue with me on the start of my theory, let me just finish my logic reasoning under the theory and derive testable or refutable implications. Only until then do you have reliable targets to object. If the implications are mercilessly refuted, I then have to consider my postulate was wrong."

Sometimes those unarguable postulates or axioms may seem groundless and very incredible. For example, an important postulate in maths says: "Given one plus one equals a number, which is called two; and given two plus one equals another number, which is called three ..." Sounds pretty silly. But without this postulate, we have no idea between one and two there can't be another number. If we argue on this foundation, then how can ever the maths theory develop?

Here is another example. In geometry, a straight line is the shortest distance between two points. Kind of hard to take, but it's far less abstract than the postulate about a point. Geometry states: "A point is unmeasurable!" Given a point is unmeasurable, how can there exist a measurable straight line?! But it just based on these specious but legitimate starting points, that geometry guided the constructions of ancient pyramids over the world (though these postulates were not clearly understood at the time), and the modern Bank of China Tower in Hong Kong. Out conclusion is: postulates that seem groundless can lead to acclaimed learnings.

Chapter 2, Section 1: Individual Makes Decisions

The first postulate in economics is: "individual" is the unit of all economic analysis. That's is saying, any group of people, organization, society or nation cannot be the starting point for analyzing economic problems. Analyses like macro economy, social welfare, or government policies all must be based on individual.

In economics there is no theory based on collective. No matter how "macro" its opinion is, or whether its starting point is mentioned or not, if not based on individual, the theory cannot be desirable. That's to say, analyzing macro economy has to be based on individual as well. Of course, there are theories that are based on collective or even the entire society, but they are detached from real foundation. Time and time agan we can hear the sayings like the macro is more important than the micro, they are just from those that don't have any economics background. The macro is summed up by individuals, therefore the difference between the macro and the micro is just size. In modern economics, some scholars classify the macro and the micro according to their emphasis of monetary, instead of the sizes.

When individual is the unit, we don't discriminate male or female, old or young, sane or insane. We don't care A is genius or B is stupid, and just treat them both individual. And "individual" itself is distinguishable to anyone capable of observation. What's equally important, the foundational postulates cannot flip-flop. The "individual" postulate is no exception. We cannot just base some problems on individual and some others on collective. Certainly, there are problems about collective instead of individual, but when dealing with them, we still need start from individual.

Why is "individual" so important? The answer is, every choice and selection is only made by individual. The choice of a collective is just a combination of the choices of its individuals. That's to say, even when someone loses his freedom under a totalitarian government, forced, it's still he that makes the choice. In other words, there is neither absolute unfreedom, nor absolute freedom; a choice must have constraints, and it's made by individual.

So economics's first postulate is that individual makes decisions and choices. In this postulate there is an unobvious philosophy. Economics explains phenomena by predicting human behaviors. We say all human actions are by decisions. Whether the decisions are wise or not, reasonable or not, is not important, what's important is that individual decides. Whether human actions are by decisions or just totally random and blind, it is not important; the important is we always follow this postulate or axiom.

That "individual makes decisions" is a convention of only economics. It seems different from those in other natural sciences. When explaining physical phenomena, physicists don't say the behavior of an object is the result of its choice. Well, in principle if physics says objects make decisions, It's actually OK, but physicists didn't do that. Every science has its starting points, and they are beyond argument. Once enough people accept the postulate "individual makes decisions", all problems of economics become problems of choices. That the most important theory for economics — price theory — is also called choice theory, it does have a reason.

To explain human behaviors with the choice theory certainly requires the behaviors are predictable. Precisely speaking, the first axiom of economics is any human behavior arises from a predictable individual choice. This is an axiom, a postulate of economics, no matter right or wrong, it's no arguable. 

(Translator: Not like in mathematics that postulates are denied by logic contradictions, i.e. based on a same postulate different paths of reasoning lead to inconsistent conclusions, postulates in empirical sciences are negated by the deviation of their implications from real world observations. Although the author says it doesn't matter whether the postulate "individual decides" is right or wrong, he fails to point out that the postulate "individual doesn't decide", which is theoretically legitimate, gets abandoned immediately.)