When building an economic model, economists describe consumers using a utility function – that is, a function which takes as its input the bundle of goods that are being consumed and outputs a value called the utility, which can be roughly thought of as the subjective benefit the consumer experiences as a result of consuming that bundle of goods. A common utility function used in trade and other macroeconomic models is the CES (constant elasticity of substitution) function. A key feature of this function is that it implies that given fixed prices for all goods, the demand of a consumer is some fixed proportion of their income. That is, if their income doubles, they buy double the amount of every good. While this is mathematically useful for building a model of aggregate demand (the sum of demand of all consumers) and can produce accurate macroeconomic models, it sits badly with microeconomic empirical evidence. Engel’s law – which is more accurately an observation rather than a law
The influence of the state on the economy is legitimised through two main aims: increasing the options available to the individual – and hence their liberty – by securing broad-based prosperity, and addressing externalities and frictions that the market cannot address, thereby also increasing prosperity, increasing the options open to individuals, and protecting individuals from unreasonable harm. These obligations create distinct pressures in the short-term and the medium-to-long-term. For the former, it is clear that right now, moves need to be made to address both the real-terms deprivation that households are experiencing and to address the closely related issue of excessive inflation that is rapidly eroding the value of people’s income. For the latter, the only sustainable way of improving broad-based prosperity is to increase productivity per hour worked, allowing incomes to grow or individuals to take increasing amounts of leisure time without sacrificing current living standard