Pure economic theory - logical action and the “fact of choice”

The theoretical formalization of choice theory was initially developed by Pareto in his two part article, “Sunto di alcuni capitoli di un nuovo trattato di economia pura” (1900b [2008]), which demonstrated that, for a system of indifference curves in which each curve is labelled by an index number, the shape of the indifference curves is unaltered when an arbitrary transformation function is used to change the index numbers.

However, the introduction of ordinalist indexes was not “an end” to Pareto; rather, it was a means to the end of making economics a more experimental science by focusing on the “fact of choice” and dispensing with considerations on the motives for choice. The statistical problem presented here depends on data from the observation of choice, which Pareto characterized as “facts” that may be obtained through either binary choice experiments (when investigating potential movement in choice space) or interpolation (to estimate the equation for indifference curves in the area that is close to equilibrium). As noted in the Manual:

The notions of lines of indifference and lines of preference were introduced into the science by Professor F.Y. Edgeworth. He started out from the concept of utility (ophelimity), which he assumed to be a known quantity, and from it deduced the definition of these lines. I have inverted the problem. I have shown that, starting from indifference lines, given directly by expe­rience, we can immediately obtain the determinateness of economic equilibrium and work back to certain functions, including ophelimity if it exists; or at any rate we can deduce the ophelim­ity indices.

Interestingly the early literature on ordinalism by Hicks (1934), Lange (1934), and Hicks (1939) all referred extensively to the French-language Manuel (1909) with some noting that systems of ophelimity were sometimes set up ordinally but with cardinal restrictions also imposed - most notably in the extended appendix - which some com­mentators consider confused. However, in the earlier Italian Manuale, Pareto took much greater care to clarify exactly when index numbers (I) are considered: one, as a function (Φ) of consumer goods on the basis that ophelimity is a quantity (cardinal function); or two, as a function (Ψ) of consumer goods when indifference curves are determined from direct observation. This can be seen first-hand in the English language variorum edition of Pareto’s Manual (1906, 1909 [2014]).

The Manual also re-specified economic equilibrium as a general theory of transfor­mations. Specifically, Walras’s economic theories of exchange, production and capital formation are absorbed within a more general formulation where equilibrium is consid­ered as the balance between an individual’s “tastes”, defined by individual’s choices, and “obstacles” represented by the costs of transforming goods in response to tastes, either through exchange or the production process.

The equilibrium between tastes and obstacles is then considered for three types of phenomena. Type I phenomena characterizes the case where individuals act economi­cally to realize a direct benefit with market conditions determined by voluntary pursuit of direct tastes without strategic interaction. Type II phenomena characterizes the case where individuals act to increase the indirect benefits from their actions through stra­tegic behaviour that modifies the market price. Kirman (1987: 806) has highlighted the originality of Pareto’s analysis of the type II phenomenon because it explicitly recog­nized actions to influence prices and examined equilibrium in the context of what is now termed monopolistic competition, well before monopolistic competition was integrated within general equilibrium frameworks in the 1960s. Type III phenomena characterizes the case where collectivist action is intended to maximize a given notion of welfare (for example, a socialist state).