Material needs and aggregate demand (WP)

A central conclusion of the standard theory of consumption is that consumers’ preferences can be taken as theoretical primitives. Special categories of consumption, such as “basic needs”, or of goods, such as “subsistence goods” are seen as extra theoretical baggage that add few, if any, insights.

This theoretical orientation has been absorbed into the theory of aggregate demand, but the aggregate theory has a serious problem that is not shared by the individual-level theory: no matter how well-behaved the individual-level demand functions may be, the aggregate-level function can take on almost any form.

This result follows from the SMD theorem, named after Sonnenschein, Mantel, and Debreu, who developed the theory; Kirman and Koch strengthened the results, and the SMD-KK theorem poses a fundamental challenge to models linking micro and macroeconomics.

A standard response to the aggregation problem is to introduce a representative agent, but this merely sidesteps the problem. This paper argues that the aggregation problem arises, in part, because of the exclusion of needs from the theory. Specifically, it argues that material needs – such as basic needs for energy, water, food, and shelter – must be included as theoretical primitives because both the needs and the satisfiers of those needs are universal.

The author constructs a microeconomic model with material needs and shows that the form of the aggregate excess demand function is not completely arbitrary, so the SMD-KK theorem does not apply. He then discusses the implications of this result.

Note: This paper has also been submitted to a journal and is under review.

Download the paper (external link to IDEAS)