Surrogate Demand: A Note on Demand Theory

Challenge, Nov, 2000 by Harry Greenfield

We don't do all our own spending. Increasingly, we employ surrogates such as architects or lawyers, who spend our money for us. What is the consequence for economics?

SOME twenty years ago, I showed Abba Lerner a page of my writing that purported to be, I thought, a needed addition to demand theory. At that time, Lerner was teaching at Queens College (CUNY), my home base. He was less than enthusiastic about my contribution. Along with a legion of others, I was, and still am, awed by Lerner's analytical ability and broad-based knowledge. After all, I had assembled a Festschrift in Abba's honor and felt (as did, among others, Paul Samuelson) that Lerner should have gained a Nobel. My reluctance, therefore, to submit my idea for publication, when it had not had a positive impact on Lerner, is understandable. I shelved the page.

Unfortunately, Lerner is no longer with us. However, that notion I had refuses to remain dormant, so, after having been emeritused for more than a decade and before cognitive diminution becomes even more apparent, I have decided to set the thought down.

Stated simply: Consumer demand ought to be viewed not as a monolithic concept but, rather, as consisting of two parts--namely, direct demand and indirect, or, as it is here termed, surrogate demand. (A surrogate, according to Webster, is "one appointed to act for another.") Total demand, therefore, would be equal to direct plus surrogate demand. Some examples will illustrate: When a consumer buys a pound of apples in the supermarket, she or he is demonstrating direct demand, that is, no third party (surrogate) is involved in the transaction. On the other hand, when a consumer employs an architect to lay out plans for an addition to his or her home, it is the architect who then determines the amount and direction of spending. [1] Similarly, the consumer may employ a lawyer to pursue a case, the ultimate cost of which may not be known until all of the facets of the case are explored. Further, a consumer may have a discretionary account with a broker who then decides where and how much to invest. The purchase o f a mutual fund is, in effect, a discretionary account since the fund managers determine investment strategies.

One has only to consult the classified advertisements in the daily press under the heading of "Professional Services" to see the vast array of services available to consumers or firms, virtually all of which are, by definition, surrogates. A perusal of the Yellow Pages of the telephone directory reveals an even larger quantity of surrogates--consultants of various kinds, interior decorators, financial managers, and the like.

Obviously, with advancing technology (in the case of the Internet, the adjective should be leaping), the individual consumer must rely increasingly on surrogates of one kind or another, with the result that over time the ratio of surrogate to total spending will increase.

Our concern in viewing consumer demand in this manner is not with the determinants of consumer choice or with optimization per se or satiation or, as Kelvin Lancaster has put it, "the properties or characteristics of the goods from which utility is derived" (Lancaster 1991). The focus here is primarily on the mechanism of spending, namely, on the linkage between total spending and its two components. The pricing of goods and services is likewise not in our purview. However, we are concerned with the impact of surrogates on total spending.

Technology apart, surrogate spending will vary with consumer income, rising as income rises and falling when income declines--with suitable lags. Demographic changes (the elderly are not likely to have additions built to their homes), as well as education levels, likewise have an impact on the demand for surrogates.

It would seem to follow that the demand elasticity for surrogates, relative to consumer income, will be greater than that of the elasticity coefficient--again with respect to consumer income--for direct (nonsurrogate) consumer spending. The hypothesis here is that an increase in consumer spending may, in all probability, lead to a relatively greater increase in the income of surrogates and vice versa. For instance, an increase in consumer income may trigger a desire for a larger house or, as mentioned earlier, for an addition to an existing one. In either case, the demand for architectural and other ancillary services (e.g., brokers, accountants, lawyers) required to perform the work will, of necessity, increase. Conversely, should the consumer experience a decline in income, the ensuing cancellation of the project will result in the surrogates' loss of expected income. As we know from studies of the marginal propensity to consume, direct consumer spending may not, in the event of an income decrease, decline materially, whereas the spending of surrogates may experience significant declines. Depending on the overall quantity of surrogate activity in the economy as a whole, a degree of instability is thus introduced into the process of aggregate income determination.