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A SURVEY OF ECONOMIC PRINCIPLES
RELEVANT TO FAMILI INCOME USE

by

DOROTHY Z. PRICE

A PROBLEM

Submitted to the College of Home Economics
Michigan State University of Agriculture and
Applied Science in partial fulfillment of

the requirements for the degree of

MASTER OF ARTS

Department of Home Management and
Child Development

1961

THESI

, A5.

 

Introduction. . . . . . . . . . . . . .
Review of Literature. . . . . . . . .
Procedure . . . . . . . . . . . . . . .
Status of Theories in Social Science.
Choice of Relevant Disciplines. . . .
Relevant Concepts in Economics. . . .
Risk and Uncertainty. . . . . . . .
Utility Theory. . . . . . . . . . .
Consumption Function. . . . . . . .
Conclusions and Recommendations . . . .
Conclusions . . . . . . . . . . . . .

Recommendations . . . . . . . . . . .

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.36

Introduction

Why does one family save a large share of its
income, another spend a higher than average amount for
clothing or furniture, and still another a very large
sum for education? Two important determinants, of course,
are the values and goals held by the different families.
ThEse are essential features in the process of decision-
making, but areithep all that are required? It is felt
that the actual method or reaching a final choice takes
much more into account. Values and goals form the essential
base; this has been assumed by many researchers. Gross
and Crandall say:

Something underlies and directs even simple
decisions, even though the decider may be
unaware of the nature of these deciding forces.
These forces aie spoken of as values, goals

and standards.

After these are established, we then need still to
know more about the members of the family, how they work
together, as well as other major and minor peculiarities,
which are incorporated in decision-making. All these
factors are necessary for the formulation of a general
theory of human behavior, of which financial planning is
a.part.

For many years, social scientists have been

attempting to formulate some such theory. Sociologists,

psychologists, economists and others have worked toward

 

llrma H. Gross and Elizabeth Crandall, anagement
for Modern Families (New York: Appleton-Century-Crofts,
Tnc., 1954), p. 36.

 

 

 

 

2
this, but much yet remains to be done. Many concepts
must still be defined, relationships between them
established and hypotheses formulated and tested prior
to beginning the construction of a theory.

This study is an attempt to work toward one such
partially-formalized theory, in the area of family
financial planning. The field of human behavior is so
broad that in order to approach it rationally, it is
necessary to limit study to a specific area. Finances
appear to be more tangible and perhaps more easily
defined and recognized than some other areas of family
behavior. For this reason, it appears to be a logical
starting point.

Most studies dealing either with family behavior or
family use of finances have been empirical surveys.
Whereas such studies are essential, it is necessary to
pull them together and through use of basic concepts
show the pertinent relationships present in them. It
is only by so doing that we can arrive at the stage where
we can study an individual family and be able to success-
fully explhin and predict their financial behavior.

Until such relationships are known, surveys will be
unable to be utilized to their fullest advantage, for
without any theory we do not even know what we should

observe.2

 

2Philipp Frank, Philoso¥hy 9£_Science (Englewood
Cliffs, N.J.: Prentice- all, nc., 1957), p.4.

3

As a science develops, laws and concepts accumulate
with a vague awareness of some connections among them. At
a certain point in its development it pays to arrange this
material into a theory. Home management, as a distinct
discipline, may well profit from such a theory of its
own. While it can make use of partial theories formulated
in other areas, since it is primarily interested in an
over-all or integrated view, it would be preferable that
a broader, integrated theory be utilized. Once such a theory
is formulated, a researcher will then know what depends on
what, and how and why. It will be a guide for searching
for new laws and new significant definitions. Only then
will be known what has been overlooked and what has been
taken for granted.3

Since concepts of other theories are necessary in
formulating a new theory, it is hypothesized that
several areas of social science can provide some concepts
which can be integrated, and from them deduced hypotheses
which may lead to a theory of family financial behavior.
The few theoretical works done in this area, as well as
the philosophical background of science, have led to this
hypothesis, which in turn forms the basis for the three
objectives of this study:

1. Social science encompasses many areas. Those
fields which appear most pertinent to family finance will
be chosen as sources of possible concepts useable for
such a theory.

3§ustav Bergman, Philosophl 2i Science (Madison,
Wis.: University of Wisconsin Press, 1957), p. 18.

 

 

 

4

2. There are many arguments about the existence of
theories in social science. It is necessary to determine
what is the position of theories in this area; how they
are formulated and the possibilities of a formulation of
a theory of family financial planning.

3. One basic area will be chosen for more inten-
sive study. The concepts which appear to be most
relevant to family finance theory will be further
examined and clarified.

Review 2; Literature

As has been mentioned, there has been relatively
little theoretical study done in this area. The main
emphasis has been on how consumers spend their money.
Such data is found in consumer studies done by Ferber4,
Juster5 and others. Elaborate new studies of this kind
are now in process at the Survey Research Center of the
University of Michigan.

What theoretical studies have been made center
primarily about aggregate consumption and saving, and
seldom make any thorough breakdown into different areas
of expenditures.

Ruby Turner’lbrris5 pointed to a need to differ-
entiate between long-run and short-run consumer theory.
The short-run view takes into account a period of time
_—-___-1R3bert Ferber, §_§tggy of Aggregate Consumption
Functions (New York: National Bureau of Economic
Research, 1953).

5Francis Juster, Consumer Expectations, Plans and
Purchases (New York: National Bureau of Economic Research,

1959).

6Ruby (Turner) Norris, The Theory 2£_Consumer Demand
(New Haven: Yale University Press, 1952).

 

5
when no changes in income or established consumption rates
occur, while the long-run view is looked upon as being
more realistic: people buy as a part of a going process
and chose among clusters of goods, instead of single
commodities.

What is perhaps the clearest statement of the state
of consumer theory in economics is outlined in Cochrane
and Bell's Economic§_g£ Consumption.7 No new theory is
offered, but the lajor pbints of view of consumer
decision-making are drawn together. Primary emphasis in
this text is devoted to the revival in importance of
utility theory.

George Katona has used the interdisciplinary
theoretical and empirical approach to the problem of how
and why the consumer spends his money as he does. By
using psychological and economic tools, he has attempted
to show how consumer behavior is not completely rational
nor completely impulsive, but yet that some type of plan-
ning is present which concefls itself primarily with a few
important decisions which change the habitual flow of
expenditures.8

In his most recent book, Egg Powerful Consumer,9

Katona delves further into specific psychological and

economic concepts. Here he points out instances where

 

YWillard Cochrane and Carolyn Bell, The Economics
9; Consumption (New York: McGraw Hill Cot Inc., 1956).

8
George Katona, Psychologgcal Analysis of Economic
Behavior (New York: McGraw Hill Co. nc., 195T).

9George Katona, The Powerful Consumer (New York:
McGraw Hill Co. Inc., 1965).

6
seemingly conflicting views from the two fields are
actually supplementary. Classical economic theory postu-
lates a single comprehensive motive - the maximization of
utilities, while modern psychology postulates that
behavior is multimotivated. He integrates these two
approaches by assuming that the multitude of forces repre-
sents a description rather than a systematization and can
ultimately be reduced to one goal.

Economists, though many have displayed a tendency
to underplay the theory of consumption , have however
contributed several noteworthy studies. Boulding10 looks
at the consumer as a miniature "firm", at the final stage
of production. The final product for the consumer is the
psychological one B utility, which is therefore the ulti-
mate product of all economic ability. He then goes on to
build his theory primarily on the concept of utility.
Though he infers the importance of psychology, there is
little reference to it in the theory itself.

In his study of consumption and savings,11 Duesenberry
formulated a theory of consumer saving which he considers
as a step toward a broader, more inclusive study. He
bases it on the assumption that consumer preferences are
interdependent and irreversible.

In home economics, most of the attention devoted to

 

16Kenneth Boulding, Economic Analysis (New York:
Harper and Bros., 1955), p. 351.

11James Duesenberry, Income, Savin and the Theory
g£_ onsumption (Cambridge: Harvard Ufiiversity Press,

0
952).

 

 

 

 

I

r‘,‘

7
consumer theory dates back several decades. In 1923,
Kyrk,12beginning from "nothing" worked on a theory built
around the standards of living. This, she wrote, was

the most neglected area of consumption. She too noted the
importance of a psychological approach, mentioning that
the study should necessarily include a query into the
"organized motives and impulses which determine human
conduct."

Hoyt, too, has based much of her work on the
standard of living approach. The central focus of her
work is the theory of maximizing satisfactions.13 This
takes into account four elements: increasing the supply
of factors (factors are defined as purchasing power, time
and energy and choicedmaking); knowing the alternative use
of factors; increasing utility by expanding appreciations,
and balancing choices.

With the exception of the contributions of Kyrk
and Hoyt, little theoretical work referring to family
finance has been done in home economics.

All studies, done in various disciplines, can be
grouped in several categories:14

1. Consumption function studies

2. Studies of the major components of expenditures

3. Studies of the purchasing process

 

lgfiazem Kyrk, A Thebr 2; Consumption (New York:
Houghton Mifflin Co., 1923).

13Elizabeth Hoyt, Consumption in ODr Society
(New York: McGraw Hill Co. Inc., 19387.

1'I'Lincoln Clark (ed.), Consumer Behggiog: Research
on Consumer Reactions, Vol. III (New York: Harper Bros.,

T558).

8

4. Studies based on the family cycle as an
explanatory variable

5. Studies focused on aspiration levels

6. Studies on the importance of conflict and
habit

7. Studies of utility and subjective probability

8. Studies of the relation of attitudes to
behavior and of events and eXperiences to attitudes

This survey of literature indicates the sparcity of
work which has been done to develop a theory of financial
planning of families. However, the partial theories in
other related disciplines and the wealth of empirical
data available indicate definite possibilities for the
beginnings of the formulation of at least a rough

theoretical outline.

0

 

Procedure
Status 2; Theories Lg Social Science

A theory is a general principle or formula pro-
pounded for the purpose of explaining phenomena; it is the
result of systematic scientific consideration. A
hypothesis is any assumption of a fact or connection of
facts from which can be deduced an explanation of a fact
or connection of facts already known.15 It is in this
sense that the words "theory" and "hypothesis" will be
used in this paper.

Since the long-range aim of this study is the
eventual formulation of hypotheses which can lead to a
constructed theory, it is essential to first understand
the fundamental nature of theories, especially in regard
to the social sciences.

Ideally, an empirical scientific theory will
comprise an eXplicitly articulated deductive system into
which new concepts are to be introduced by means of
explicit definition in terms ultimately, of the primitives
(the basic elements) of the system.16 In social science
however, it appears that we shall have to rest content
with something short of full formalization; but partially

formalized theories are definitely possible. These

 

T5Eames Baldwin, Dictionary of Philosophy and
Psychology (New York: The Macmillan Co., 1925), pp.

16Richard Rudner, "On the Structure of Economic
Theories,“ Paper read before a Joint meeting of Agricul-
,.tural Economics - Economics Departments, M. S .U.

9

lO
theories focus attention on terms or concepts nonin-
digenous to them, meaning that these terms or concepts
are not basic to the discipline being discussed. They
serve to indicate that some portion of the results of
some other discipline is being presupposed in the theory.
Since this study is attempting to make use of work
already done in other theories, the use of indigenous
terms will be very important.

One problem with what are often called theories in
social science is that they are not theories, neither
fully nor partially formalized. These are instead
idealizations which are simply convenient shorthand tutu.
niques for referring to a rather complex set of connected
conditions.17 However, even these idealizations are
rich in relevant concepts.

Although theories in social science are not as
sophisticated as those in natural science, they nevertheless
are relevant in these disciplines also and can be formu-
lated in the same way - by systematic deduction of
related sets of lawlike statements.18
Choice 9; Relevant Disciplines

Since we have found that theories of a sort can be
formulated for and do exist in social sciences, there is
a logical basis for proceeding to work toward a family

finance theory.

 

jfii'bi d .

18Richard Rudner, Notes from Philosophy 403:
Philosophy of Social Science.

11

The first step is to choose the discipline or
disciplines which can provide the most relevant concepts.
The core of this problem rests with decisiondmaking;
therefore, the most promising fields for the beginnings
of a new theory are business management, economics,
psychology and sociology. In these four areas, many
concepts appear to be well-defined.

The area of business management can be eliminated
first, since it deals with a different type of group -
the corporation instead of the family. Even more
important is the fact that it is built largely on
psychological and sociological principles. These two
basic disciplines will instead be surveyed.

The family, composed of a small group of individuals,
can be studied best through use of sociological concepts -
study of groups, and psychological concepts - study of
individuals. Both of these disciplines are composed of
various subdivisions. Social psychology, defined as
"the branch of psychology which studies psychological
conditions underlying development of social groups and
the development of the behavior of the individual, in
relation to his social environment, or generally all
problems having both an individual and a social aspect,"19
is the area most likely to contain principles pertinent '
to family behavior. .Relevant concepts here include

attitudes, eXpectations, habits, motives and perception.

 

. 1§3ames Drever, g Dictionary of Psychology (New
York: Penguin Refernnce Books, 19527: p.

12
A later study fwill concentrate further on the principles
derived from these concepts. It will be sufficient here
to merely state that social—psychological concepts can
provide important inroads toward formulating any theory
involving the family as its basic unit.

Since the prospective theory is to deal with finances,
it is necessary to rely on basic economic terms. Economics
therefore, is essential in constructing any financial
theory.

The broad scope of this study, then, will concen-
trate on investigating thoroughly the disciplines of
economics and social psychology and then formulating these
findings into a set of hypotheses which attempt to eXplain
the reasons families use their incomes as they do. The
remainder of this paper will be devoted to a further
investigation of the various areas of economics in order
to choose the most relevant ones.

Relevant Concepts i§_Economics

A survey of basic economic texts by Boulding,2°
Samuelson21 and Marsha1122 led to six areas which appeared
to have some relation to family use of income. These
include: welfare economics, real income, economic man,
risk and uncertainty, utility and the consumption function.

Welfare economics is an entire sub-field of economics,

having as its aim the attainment of economic well-being

 

26Soulding, 9p. cit.

21Paul Samuelson, Principles 2; Economics

22Alfred Marshall, Principles 2; Economics (New
York: Macmillan, 1949).

13
resulting from the receipts of an adequate share of results
of production commensurate with time, effort and ingenuity
utilized in production.23

While it fascinates many, welfare economics does
not appear at any time to have wholly engaged the labors
of any one economist. Many dabble in it, but the-uneven-
ness of its development has resulted in a distressing
disconnectedness between its parts. Most work in
theoretical welfare economics, as in most economics,
uses as its base the whole of society instead of the
individual. Most studies have centered about formulating
propositions by which alternative economic situations open
to society can be ranked on a scale of better or worse.

It is doubtful whether the area of welfare economics
can reveal many useful principles partly because of its
broad scope and partly because of its already mentioned
discontinuity. A study of welfare in economics confining
itself to the measurement of quantities of goods and their
distribution is seriously limited and often even misleading.
The things upon which happiness ultimately depends -
friendship, faith, perception of beauty, and so on - are
outside its range, and therefore we can never determine
whether the achievements of modern day many be exacting a
fearful toll in terms of human happiness. Welfare
economics deals primarily with indices of satisfaction

derived from measurements of material possessions.24

 

é3Eyron J. Horton, Julien Ripley and M.B. Schnapper,
Dictionary 2; Modern Economics (Washington: Public
Affairs Press, 1948), p. 109.

24E.J. Mishan, "A Summey of Welfare Economics,"
The Economic Journal, LXX.(June, 1960).

 

14

Because of these lackings in welfare economics,
further investigation of it will not be made. In a larger
sense however, since the prime aim of welfare economics is
to increase well-being, all principles to be used will,
in a way, be encompassed by it.

Real income is a troublesome concept to define and
can be approached in two ways, which though different, are
likewise similar in many aspects. In one view, real
income is defined simply as the reduction of monetary
units to their real terms by correcting for changes in
the price level of goods.25 From another point of view,
real income is seen as a flow of commodities and services
available for the satisfaction of human wants and needs
-over a given period of time. It includes all material
goods and services, either produced or purchased.26 Real
income however does not appear to be particularly useful
in the study, since it does not pertain directly to
how income is used; its importance is centered rather in
determining what comprises income and what it is worth.

The term "economic man" has long been one of
importance in economics. For many years, most economic
theory was based on the fact that man acts rationilly.

It was largely developed by classical economists and is
really an abstract concept of an individual whose actions

are solely motivated by economic self-interest or the desire

 

25Alvin Hansen, A Guide to Keypes (New Ybrk:
nacraw Hill Co. Inc., 195'3"5',""'."£o.

26Gross and Crandall, op. cit., p. 138. .

15
to maximize his economic gain with the least possible
effort.27 According to this, a man makes decisions by
balancing costs against satisfactions, attempting to
obtain the greatest satisfaction for the least cost.28

However, in recent years, this concept has been
pushed further and further into the background by
economists. In order to act like an economic man, an
individual must have complete knowledge of the satisfac-
tions and sacrifices which each of many possible
alternatives present. The variables in behavior are so
many and the constants so few, that using the principles
derived from "economic man" have been abandoned by many
economists. However, in abandoning this "theory", they
have likewise abandoned much theoretical study in this
area, and turned instead to factual data analysis.

Risk and uncertainty are inherent in most decisions
and are essential components in the study of choice-
making in economics. Risk is defined as any exposure to
loss, injury or destruction. It is usually distinguished
from uncertainty in that it implies the formation of an
expert or statistically arrived at Judgment of probability,
a possibility which is excluded from the concept of un-
certainty.29

Although risk and uncertainty principles have most

frequently been applied to economics of the firm, it is

 

Z7Horton, et. al., 22. cit., p. 106.

28William Loucks, Comparative Economic Systems
(New York: Harper and Bros., 1957), p. 22.

29Horton, et. al., pp. cit., p. 290.

l6
quite likely that some of them can be adapted to the
economics of the family, since they are inherent in all
decisions.

The principle of utility constitutes the core of
economic theory of decision-making. The utility school
of economics was developed in the nineteenth century by a
group of economists who claimed that value is determined
by relative marginal utility and that this is a function
of the quantity of goods possessed. (Marginal utility,
in turn, is the increase of total utility of any quantity
of a commodity resulting from a unit increase in the amount
available for consumption.) These economists suggested
that this quantitative approach to consumption was the
only sound basis of theoretical principles.30

Whereas the principles of utility and the economic
man are largely inter-connected, it appears safe to assume
that some of the principles of utility could be combined
instead with some more up-to-date principles of human
behavior.

The consumption function is an important element of
the "new" economics as developed by J.M. Keynes. It
describes the relationship between national income and
total consumption at different levels of that income.31
As the definition implies, the consumption function deals
with aggregate economics. It however offers such an
excellent framework of economic behavior, that it is quite
"————-—3°Ibid., p. 346.

31John M. Keynes, The General Theory of Employment
(New York: Harcourt, Brace and Co., 1935? p. 90.

17
possible that some pinciples derived from it can prove to
be equally valuable in the study of individual or family

use of income.
Keynes singled out income as being the main

determinant of consumption. The slope and position of the
A

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/

_/

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o 7 IE‘JUO’WE
consumption function, in turn, depends on both subjective

 

 

factors, such as providing for future needs and desiring
a sense of independence, and objective factors, such as
unexpected windfalls in income and changes in expectations.32
Since Keynes takes into account psychological, as
well as economic variables, his work offers a promising
framework upon which to build a new theory. Even though
his work is with the aggregate and the consumption function
operates only to determine the part of income to be
consumed and the part to be save, instead of the more
exact use of income,some of the principles when examined
in light of what is known about utility, risk and
uncertainty, together with psychological data, can prove
to be invaluable.
Risk and Uncertainty
All behavior entails a certain degree of risk and
uncertainty. Frequently these two terms are used inter-
changeably; however, there is a distinct difference between
them. Risk is measurable while uncertainty is not. In

32Hansen, pp. 9_i_._t., p. 69.

18
risk, the distributibn of outcome in a group of instances
is known, while in the case of uncertainty this is not true,
the reason being, in general, that it is impossible to
form a group of instances, because the situation dealt
with is in a high degree unique.33 It is this "true"
uncertainty, not risk, which is of importance in the study
of financial behavior. The following principles have
been formulated largely from the material in Knight's
Risk and Uncertainty.34

Principle I: Everyone aims towards an ultimate

 

level of equilibrium.

Equilibrium is an indefinite and usually far
distant state, for either all of society, a firm or a
family. It is viewed as a result of a particular tendency
which may be modified to any extent or reversed by the
effect of other tendencies, or the conditions may be
entirely changed by unforeseen developments long before any
noticeable approach to equilibrium is reached. In order
to attempt predicting the course of future events, all
of these interacting tendencies must be taken into account,
and their relative importance estimated. Even considering
this, a wide range of flexibility must be allowed in
order to include any unpredictable influence. Because
of the inter-relatedness of so many factors, many of which
are often unknown or affected by numerous variables,
definite predictions extending o'er a long period appear
to be out of the question. However, a short-range view

33Frank Knight, Risk, Uncertaint and Profit
(New York: Houghton Hifflin Co., 1921).

Ibid.

19
of equilibrium levels may be valuable, especially when
analyzed in conjunction with utility theory. Both of these
principles are interconnected.

Principle II: Theory of progress and change.

This theory is most frequently applied to society
as a whole and takes into account six factors: population
numbers and composition; tastes and dispositions of people;
amounts and kinds of productive capacities in existence; 4
distribution and ownership of these productive capacities;
geographic distribution of people and things, and the
state of the arts. Slight changes in most of these
factors can enable us to apply this theory, at least in
part, to the family and specifically to their use of
income.

Population numbers and composition is simply
translated into family size and composition. The tastes
and dispositions of the family can be analyzed in a manner
similar to those of all members of a society. This holds
true also for productive capacities present and their
distribution among family members. Geographic distribution,
though perhaps not as vital and pertinent, can still be
considered since the section of the country where one
lives has some influence on how income is used, as do
rural-urban differences. The state of the arts, while
again referring to the whole, has a definite influence on
the family. The level and extent of knowledge in various
areas has a marked effect on individual members of a

family and the family as a unit. These factors can all

20
be considered as conditions of demand, therefore forming
some background for family financial use.

Principle LII: Uncertainty depends partially on
degree of knowledge.’

Imperfect knowledge of the future, which is a
consequence of change, and not change itself, is crucial
‘to the whole problem of uncertainty; If all changes took
place in accordance with invariable and universally known
laws, they could be foreseen for an indefinite period in
advance of their occurrence and would not upset the
perfect apportionment of product values. Many changes do
occur with sufficient regularity to be practically
predictable - it is these events about which there is
much knowledge and uncertainty is absent. In a sense,
knowledge is variable in degree and the problem relates
to this rather than to its total absence or presence.

In dealing with prediction, two sets of factors
must be considered: the things we are dealing with and
the circumstances which condition their action. Know—
ledge of these sets of facts makes it possible to predict
expected behavior. Things must first be classified: it
must be possible to assume not merely that the same
thing will always behave in the same way, but that the
same kind of thing will do the same, and that there is
in fact a finite, practically manageable number of kinds
of things.

We seldom have perfect knowledge of all alternatives

to our decisions, and therefore most ordinary decisions

21
are based on crude, superficial estimates. In general the
future in relation to which we act depends on the behavior
of a large number of objects, and is influenced by so
many factors that no real effort is made to take account
of them all, much less estimate and summate their separate
significances.

The extent of knowledge of the situation then deter-
mines the degree of uncertainty present.

Principle £2: Different probability situations
result in different consequences.

There are three logically different types of infer-
ence included in probability judgment. A priori probability
is usually assumed in mathematical or logical treatments
of probability. It refers primarily to a homogeneous
classification of instances which are identical except for
a very small number of real variables. In referring to
any single event, a priori probability carries an intuitive
certainty.

Statistical probability, on the other hand, depends
on empirical classification of instances. Eben here
though, any high degree of confidence that the proportions
found in the past will hold in the future is still based
on a priori judgment of indeterminateness.

The probability most involved in the problem of
risk and uncertainty however, is the estimate. Estimates
can not truly be classified as a type of inference, since
inference is an exact science. Such an exact science appears

to be out of place when dealing with human behavior, so

22

in effect, both a priori and statistical probability can
be eliminated. Estimates are similar to probability
judgments, but completely different from the two types
already discussed. The distinction is that, in dealing
with estimates, there is no valid basis of any kind for
classifying instances. The only way of reaching an estimate
is through tabulation of instances, therefore reducing it
to a kind of statistical probability. The difference between
them then is actually only a matter of degree: homogeneous
classification of events is seldom possible in statistical
probability, and never possible in estimates. The main
point to remember about estimates is that the event in
question is so unique that there are no Others or not a
sufficient number to make it possible to tabulate enough
like it to form a basis for any inference’of value about
the real probability of the case in question.

Even though no "real" probability can be reached
in estimates, some type of judgment is made in each
decision. The degree of certainty felt in the conclusion
after it is reached is also important, since what a family
does depends on their confidence in an opinion as much
as the opinion itself, perhaps more so.

Principle 3} Importance of subjective uncertainty.

 

When someone undergoes a sacrifice for the sake of
a future benefit, the expected reward must be larger in
order to evoke the sacrifice if it is viewed as contingent
than if it is considered certain and that it will have to

be larger in at least general proportion to the degree of

23
felt uncertainty in the anticipation. The subjective
uncertainty is quite decisive in such a case.

Brief examination of subjective uncertainty readily
reveals its relation to that of probability estimates.
Nearly all decisions in life are based upon opinions, and
the majority of these are actually opinions of probabilities.
It is necessary to be able to make estimates of the future
demands of one's family in order to determine how best to
use present income to maximize satisfactions.

Principle 2;: Several individual attributes are
related to uncertainty.

Knight, among others, points to several capacities
of individuals in regard to uncertainty. These can be
classified into five major groups:

1. Men differ in their capacity by perception and
inference to form correct judgments as to the future
course of events in the environment.

2. Men differ in capacity to judge means and discern
and plan the steps and adjustments necessary to meet the
anticipated future situation.

3. There is a similar variation in the power to
execute the plans and adjustments believed to be requisite
and desirable.

4. In addition, there is a diversity in conduct in
situations involving uncertainty due to differences in the
amount of confidence which individuals feel in their
judgments when formed and in their powers of execution.

5. Distinct from confidnnce felt is the conative

24
attitude to a situation upon which fludgment is passed with
a given degree of confidence.

This principle, as well as several others derived
from risk and uncertainty, venture into the field of
psychology somewhat. Though primarily economic principles,
they represent some early attempts to integrate the two
disciplines and appear to still retain some valuable
guideposts to consumer theory.

Utility Theory

As has been mentioned, utility theory is at the
center of most work done in economics in the area of
consumer behavior. This has been true for a long time,
though in the 1930's, economists who held on to this theory
were scorned as being behind the times. In recent years
however, utility theory has been making a comeback. Most
of its advocates now realize its shortcomings and limita-
tions, but maintain that it should not be abandoned since
it is the only theory of consumer behavior available in
economics. If utility could somehow be measured, it
could indeed be a very valuable concept.

Utility is defined as the ability of a good to.
satisfy human wants. 35 It is subjective and exists in
different degrees in all goods and services for various
individuals. The ultimate product of all human activity
is utility, since in a sense it is synonymous with
satisfaction. Many principles are incorporated in the

theory of utility. Five of these have been chosen to be

 

D5Horton, dt. al., pp. cit., p. 346.

25
further analyzed, for it is these which refer most directly
to individual or family economic behavior.

Principla VII: Law of diminishing returns.

The total utility of a thing to anyone increases
with every increase in his stock of it, but not as fast
as his stock increases. In other words, the additional
benefit which a person derives from a given increase of
his stock of a thing, diminishes with every increase in
the stock that he already has.36 Psychologically, it
implies that the desire for any object will become weaker
at the appetite for it becomes satiated.

This can be illustrated as follows: if one eats a
candy bar, he gets a certain amount of satisfaction from
it. A second candy may give twice as much satisfaction.
However, a third one may not increase satisfactiomras much
as the second; a fourth one increases it even less, and so
on.

Boulding37 states two reasons for this diminishing
marginal utility. First of all, commodities are imperfect
substitutes, that is to say, there are certain appropriate
proportions used in the consuming of commodities. A
great change in this proportion tends to throw one off
balance and results in declining satisfaction. In the second
place, there is a certain satiability of wants. No matter
how great a quantity of something is consumed, it will
never rise above certain amounts. Every thing has a point
-—_—-__35Marshall, pp. pip., p. 91.

37Boulding, o . pip., p. 684.

26
of satiety, a point beyond which total utility can not
be increased by further consumption.

Principle 211;: Marginal rate of substitution.

The sum of money which will afford the same
satisfaction as one unit of the commodity in question is
the marginal rate of substitution. If we were able to
develop an index for measuring utility, marginal rate of
substitution could likewise be measured simply be dividing
the marginal utility of the commodity in question by
the marginal utility of money.38 Even though it is not
measurable, however, all that is necessary is that the
utilities of a quantity of foods and a.quantity of money
can be compared. All that need be known is whether the
utility of one is greater than, equal to, or less than
the utility of the other.

Marginal rate of substitution is related also to
the market, and to price. Whatever the price of a commodity,
a consumer will consume no more or no less than that
which is equal to their marginal rate of substitution.

The quantity of consumption and marginal rate of
substitution vary with one another. If the marginal
utility of money is not constant, as is the case unless
the commodity is only a small part of the consumer's
total expenditure, we can still construct a relative
marginal utility schedule if we know the schedule giving
the marginal utility of money for quantity of a commodity

consumed.

SeSoulding, pp. p33,, p. 684.

27

Principle pg; Ehuimarginal principle.

In dividing a fixed quantity of anything among a
number of different uses, just so much will be apportioned
to each use to cause the gain involved by transferring a
unit of dividend into one use to be just equal to the loss
involved in the uses from which the unit of dividend is
withdrawn.39 This principle deals most closely with the
"best" division of expenditures - that which will most
greatly increase satisfactions. A person, or family,
according to this principle, shall always have a greater
drive toward that commodity which holds more psychological
gain for him. Unless an ideal apportionment is reached
(one by which nothing can be gained by transferring a
marginal unit of one resource to another) one will always
experience a "need" for that item which holds the greatest
marginal utility for him. This principle is, of course,
closely connected with the law of diminishing returns.

As do most concepts related to utility theory, the
equimarginal principle has several limitations.40 The
first problem is quite obvious: many large commodities
are indivisible. A person can buy one or two houses, but
not one and one-half; therefore, he will spend either ten
or twenty thousand dollars. He may feel that he is spending
either too much or too little on a house in relation to
his other expenditures. One obvious solution here would
be, of course, to purchase a home for about fifteen
""""39sculding, pp. 913., p. 688.

4O£2$g.

 

a
_a-— V"

--_..o

28

thousand dollars - this midway point should then bring one
nearer to the goal of maximizing sttisfactions. The
problem with large commodities is still real, however;
for it is comparatively simple to decide to purchase one
or two sweaters, but the problem is magnified many times
when the item in question is a house or car.

A second limitation concerns the length of the
budget period, for something may be purchased in one time
period for use in another period. The benefits enjoyed
from one purpose must therefore include the satisfaction
derived from its use throughout its life span, which in the
case of a large purchase, will frequently include more
than one period.

‘ This is perhaps one of the most important concepts
in utility theory, since its purpose is to show how to
dispose of income in the "best" possible way. This is
also the ultimate aim of this study.

Principle.§: Utility an an ordinal magnitude.

Utility is ranked as high or low, needing no specific
magnitude to be stated;therefore, it is an ordinal and
(not a cardinal measurement.41 This is related to what are
known as preference scales and indifference curves. A
preference scale involves a theory of optimum choice
which puts together two sets of relationships, one des-
cribing what there is to choose among and the other
enabling us to select out of the possible choices that
which stands highest on the scale of preference.

#IBoulding, pp. cit., p. 788.

‘72.

 

29

Combinations of two quantities can then be measured on

a graph . wafl”
or

 

0 rr
0%;TI’

The vertical axis represents the quantity of

 

commodity A and the horizontal axis is the quantity of
commodity B. The circles or contours are then referred

to as indifference curves since they represent combinations
of quantities which are neither better nor worse than each
other but are indifferent. The curves WUX and YVZ are
referred to as possibility curves which divide the area
into attainable combinations lying within the area OWVX
and OYVZ, and the unattainable combinations outside either
of these areas. The points U and V are the optimum
positions among all choices available in their respective
fields, because these points are where the possibility
curves intersect the indifference curves and they are the
highest points which can be reached within the attainable
areas.

Since it is only the ordinal magnitude of utility
which is important, having a field of indifference curves
and a possibility area is sufficient for finding an
optimum point of resource use.

Principle fig: Demand curve dhanges.

The demand curve is closely related to utility curves;
therefore, changes in demand ultimately affect utility.

Four primary causes of changes in demand are change in

 

.‘r r

A

30
taste, change in income, change in saving and change
in asset preference.42

A change in taste will be reflected by an increased,
desire for a commodity and therefore an upward shift
in total utility.

Change in income operates principally to lower the
marginal utility of money. Therefore, even though income
change affects demand, it may be only through this change
in the marginal utility of money - the utility curves for
specific commodities may not change at all.

A change in savings will quite naturally result
also in a change of consumption pattern. The increased
desire to save results in the falling of utility curves
of many commodities, therefore affecting an entirely new
plan of income use.

Changes in asset preferences are generally not of
long duration, however for short period analysis, they should
not be overlooked. A difference in the liquidity pre-
ference of a family will also result in a change in the
demand for commodities.

The utility theory includes a great number of
principles and concepts, most of them dealing with the
economics of the firm. The aforementioned five however
appear to be most pertinent to the economics of the family.
Consumption Function

The consumption function is a more recent economic
tool than either utility or uncertainty. It belongs to the
moulding, pp. pip” p. 696.

31
are of "new" or Keynesian economics. In his General

Theory pg Employment, Keynes applied the consumption

 

function, marginal efficiency of capital and liquidity
preference to aggregate economics. Consequently, most

work involving Keynesian concepts has dealt with aggregates.
The ideas which he introduced however, appear to offer a
challenging framework for individual or family economics

as well. His broad insight into the factors determining
consumption is especially pertinent. In regard to the
consumption function itself, Keynes postulates three
primary principles.43

Principle XII: Consumption depends primarily upIn

 

real income.

Keynes singles out income as the chief determinant
of consumption - the level of a family's consumption than
depends on the level of its real income. (Real income is
here defined as income adjusted for changes in price.)

Consumption is seen as a function, not only of
present income, but also of the highest previous income
earned. This elaboration was formulated by Dusenberry44
who maintained that consumption is basically determined by
standards already set and can not change drastically if
income falls. If income rises however, consumption level
is more likely to rise.

The concept helps to determine what total consumption
will be at a given income. Since the problem under study

is to determine how a further breakdown of income is made,

 

it3Eeynes , pp. ci t .

44Dusenberry, loo. 1 .

.
. .
.
,.. . - . - . E- . --. . .__
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o
r
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- -. ...- .qfii-.._. .-
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_ _ , A — fl .. i _t.,‘
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4
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' " i s .
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D I I
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a,

 

32
this idea can only provide a starting point.

Principle XIII: Objective factors influencing
consumption are most important in the short-run.

The factors which determine the form of the
consumption function are both objective and subjective.
(The form refers to the slope and position of the consump-
tion function. The slope has to do with whether or not
consumption rises less than in proportion to changes in
real income; the position is mathematically calculated.)45

Keynes generally took the subjective factors as
given, since they were unlikely to change, except over a
long period of time. The objective factors then determine
the propensity to consume. He lists six factors as being
of most importance:

1. Change in the wage-unit - Since consumption is
dependent more upon real income than money income, income
measured in wage-units becomes important. (A wagerunit
is the money-wage of an hour's employment of ordinary
labor.)46 If the wage-unit changes than we can easily see
that the rate of expenditure will also change.

2. Change in difference between income and net
income - Amount of consumption depends on net income,
simply be definition of the term "net income." The
consumption function relates different levels of income to
the corresponding levels of net income. As long as this
remains stable, no change in the function occurs. However,

a change in income not reflected in net income will not

 

45Hansen, pp. cit., p. 71.

46Keynes, pp. cit., p. 41.

 

D.

I:

.~- a

33
affect the function, which a change in net income not
reflected in income will have an effect. (A change in
taxes, for example, would change net income.)

3. Windfall changes in capital-values - These are
' very important since unforeseen changes in money-value of
wealth will have a distinct effect on the consumption
pattern.

4. Changes in the rate of time-discounting —
Time-discounting roughly approximates the rate of interest.
This factor allows for future changes in purchasing power
of money in so far as these are foreseen. The effect of
the interest rate over a short span is open to question.
Few will alter a spending pattern simply because of a one
or two percent change in the rate of interest. In the
long-run however, substantial interest rate changes in
the same direction can serve to considerably alter social
habits, therefore changing consumption patterns.

5. Changes in fiscal policy - With government
assuming such large proportions in our economy, we can not
ignore its effects. Decision to tax, to borrow, to spend
and so on have a direct and indirect influence on the
consumption of every member of the society.

6. Changes in expectations - Here we encounter a
factor closely related to uncertainty, and one which
is especially important to individual families, even more
so than to the aggregate. (In the whole economy, changes
in expectation tend to cancel each other out.)

All of these changes, though referring mainly to

~t

 

34
the whole of society, can also be analyzed in reference
to the family. Further study may add several factors, or
perhaps eliminate some, however, the general area of
pertinent objective factors in here classified.

Principle XIV: Subjective factors basically
underlie and determine the consumption function.

Since Keynes' analysis dealt mainly with short spans,
he assumed subjective factors as unchanging. However,
he realized their importance in the consumption function.
It is primarily these factors which give the function its
slope and position, as well as its rather high degree of
stability. It is here that Keynes ventures into the
psychology of human behavior.

He presents two lists: one of motives which lead
to withholding spending, and a corresponding list of
motives leading to consumption. The first list includes
eight subjective motives : preception, foresight,
calculation, improvement, independence, enterprise, pride
and avarice; the secong group includes - enjoyment,
shortsightedness, generosity, miscalculation, ostentation
and extravagance.

The strength of these motives will, of course, vary
a great deal according to the institutions of the society,
and the habits formed by race, education, convention,
religion and current morale, according to scale and
technique of capital equipment, according to present
hopes and past experiences, and according to the prevailing

distribution of wealth and the established standards of life.

«fly

 

 

 

35

These than are the main thoughts expressed in the
consumption function. Alone, they perhaps can not
adequately serve to underlie a theory of family financial
use. However, in conjunction with utility, uncertainty
and some social psychological concepts, they may form a
nucleus for such a theory. It is felt that insufficient
attention has been paid to the possibility of Keynesian

concepts in both individual and family economics.

Conclusions and Recommendations
Conclusions

The hypothesis that several areas of social science
can provide concepts pertinent to formulation of further
hypotheses concerning family use of income has been
substantiated through investigation of several disciplines.
Social psychology and economics were chosen as being most
relevant and field of economics was further analyzed.

Three areas - risk and uncertainty, utility and consumption
function - were chosen as most relevant, and from these,
fourteen principle were obtained.

These economic principles frequently emphasized
their close relationship to social psychological concepts,
thus further accentuating the importance of both areas
.to family income use.

As the review of literature indicated, and the
analysis of economic studies further proved, most income
use studies are empirical and refer to aggregates. What
theoretical work has been done is largely in the area of
macro-economics, the gap therefore is in micro-economics.
(We know little about the whys behind an individual or
family spending/saving pattern.

Recommendations

This paper has been just the initial step in a
large study aimed toward eventual formulation of a theory of
family income use. A brief outline for this study follows.

36

37

To deduce hypotheses, it is necessary to have an
aquaintance with a broad range of material dealing
directly and indirectly with income use. The economic
principle analyzed in this paper will be further investigated
to determine if several should be combined or eliminated.

A similar analysis of social psychological concepts will

be made in order to derive relevant principles. Possible
areas for investigation include habit-formation, perception,
attitudes, motives and expectations.

At this point it appears that the Keynesian concepts
may serve as a foundation for the study. Other pertinent
concepts will then be injected at suitable junctures.

The economic framework will likely remain primary, with
social psychological concepts maintaining an important,
though secondary, role.

In addition to examining concepts of these two
disciplines, principles recognized in home economics (in
regard to management, family interaction, and so on) will
be taken into account. After all concepts are outlined,
several empirical studies will be examined in order to
determine the practical significance of these concepts.

At that point, several hypotheses will be formulated
which should partially explain why different families have
different patterns of income use. This present study will
go no further.

Much more work however, will be necessary. Several
studies must be undertaken in order to determine the rela-

tionships and truth or falsity of the hypotheses. It is

38
only then that a theory can be properly formulated. It is
the eventual aim of the writer to determine a method of
changing income use patterns of families. Before this
can be done, it is necessary to know what determines
income use and the process it follows; hence, the need

for a workable theory.

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39

 

.34.;-

 

 

«c-

4O

15. Katona, George. Psychological Analysis Lf Economic
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18. Knight, Frank. Risk, Uncertainty and Profit.
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19. Kyrk, Hazel. A Theogy Lf Consumption. New York:
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Miscellaneous

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26. Rudner, Richard. Notes from Philosophy 403: Philosophy
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MICH’IGAN STATE UNIVERSITY LIB RBAR

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