What It Means to ‘Maximize Profit’
Economists are often accused by members of the general public, political pundits, and others for being overly simplistic, using outrageously foreign assumptions, and being too narrow in scope. It isn’t all about money, they (non-economists) tell us (economists). Right, it isn’t.
Some of this criticism is unfortunately accurate. Looking at what goes as economics nowadays, it is hard to draw a line between economics in practice and the straw man of the discipline. In this sense, the criticism is about as accurate as economists can expect – and deserve. Yet economics is much larger than the mainstream “mathturbation” with formalized models. What is generally taught in the “principles” courses is the economic way of thinking, the economic reasoning that is the supposed origin of the streamlined models. This is at the heart of economics, and the concepts and rationales taught to freshmen and sophomores in college is in fact much more important than being able to recite Hotelling’s lemma or mathematically prove ne econometric model or the other.
We cannot learn about the world from a formalized, mathematical model: a model is always of the crap in-crap out kind – it isn’t better than the reasoning and assumptions on which it is built. (This is a big reason the mathematization of economics an the great inflow of mathematicians into the field is very problematic.) The structuring and formulating of the model is (hopefully) based on sound economic reasoning. That a model says people “maximize profits” means little without the explanation of what it is intended to represent (as proxy) or measure. Maximization in economics is not a mathematical concept, it is an economic assumption.
The critique, however, is often of the mathematical representation – not the economic concept. Perhaps this is the reason it is almost a joke among non-economists. Sadly, many modern economists are so focused on their models that they forget about the real world, which is why economists are considering new, fancy mathematical models that allow for “satisficing” rather than “maximization.” What prediction models spew out does not fit with empirical data, you see. So something had to be done. My radical suggestion is that we look to economic reasoning instead of adding layers of mathematical complexity to models that no longer represent or even resemble an economic logic. The thing is: Maximization is not a stupid concept and it is not foreign to how people lead their lives.
In fact, we do it every day and in everything we do. We just don’t do it “mathematically” and assuming “perfect information.” Life is not a simple calculus, but involves a lot of judgment, speculation, and guessing. And this is, in fact maximizing.
The simple but amazingly powerful insight that is core to economics is the trade-off. This simple notion is “obvious,” but provides important information about the world such as scarcity, valuation, and opportunity cost. Were it not the case that resources are scarce, there would be no trade-off and consequently we could all be always and fully content. But we cannot even imagine such a world, since it is so foreign to us. So we have to accept it. This means we can act in different ways, and therefore it appears rather obvious that we must choose between options. So valuation is necessary to life and action because it is the only way we can actually choose.
It is also the case that choosing, which implies that we are choosing for something as well as against something, must be based on appreciation of the anticipated outcome – the value. Whether we are successful in achieving it or if it is in reality as valuable as we anticipated cannot be known beforehand , but we of course make whatever educated guesses about these things as we can. It follows that choice is based on the actor’s anticipations, his/her beliefs and abilities, and in accordance with a want or preference. Valuation, therefore, is local and subject to the specificity of the present situation, even if we assume it is in all other respects objective. Yet we see things differently and value different things and have different views of what we’d like in the future – so valuation is subjective. It may or may not be relative, but is an act and decision by the subject.
What we’re choosing between are not simply eventual outcomes in terms of gains when finally a project or whatever is brought to fruition. Our anticipation of an action’s value is based on our expectation of whether it is “worth it” – including both the eventual outcome and the toil and trouble and resources we estimate that we need to put into it to make it happen. So we’re really thinking about the net gains of alternatives, that is te benefit that we anticipate will remain after we’ve considered the value we have invested in its realization. Only by thinking about the net gain can we actually choose whether to go through with something. The fundamental question is: will I be better off doing this than not doing it?
But that’s not all. We have different ways of acting with different outcomes anticipated at different times, so we must in every situation choose not only between action an non-action but between a whole set of heterogeneous actions and non-action. How do we compare actions? We simply compare their net gains and consider how we value time, what we will need during the time it takes to realize the anticipated outcome, and so on. One way of looking at this is through the opportunity cost of an action.
For whatever reason, students have a hard time understanding this concept that they act on every single day. The economic cost of any action is the greatest anticipated benefit of alternative actions. The cost of choosing a certain action is the net benefit of not choosing the second best. In other words, only the best option will have an economic gain; only the best alternative, at least as we see it subjectively at the time of choosing, means we are better off foregoing all other alternatives’ net benefits. It is pretty obvious, really, and is just a shorthand for saying “we choose that which we think is best (that makes us best off).”
Opportunity cost says nothing about whether we have information of all alternatives, whether our valuation is reasonable (or plain stupid), or if we have considered all that we should consider. It just means we pick that which we consider to be best.
Some question this conclusion saying we cannot know what is best – what if we err or are ignorant or simply stupid. Well, that’s beside the point. Perhaps we are stupid. But that doesn’t change the fact that we choose between the alternatives we happen to see, or that we choose the one that we consider is best. But how do we know this? Simply because we choose. We are utterly unable to choose the second or third best simply because what we’re talking about here is how we value things. Even if I believe I value X more than Y and tell everyone of this fact and then consciously choose Y just for the heck of it – then I’ve just demonstrated that there was something about choosing Y that was more valuable to me at that moment than actually choosing X (perhaps I value “for the heck of it”).
Is it tautological? You bet. But only because we separate the action from the value in our analysis, but this is hardly possible in reality: an action is valued for what value it is anticipated to provide us with. The value of an action is the action’s value, and this is expressed in whatever terms we consider important and relevant at the time of choosing. This is why choosing, even if it is by throwing a die, always indicates the greatest value – the actin with anticipated economic gain.
Suddenly the statement that we “maximize profits” doesn’t appear strange or outrageous. “Profit” is just another way of saying that we anticipate a gain (the very purpose of acting in the first place: to make us better off), which is in terms of subjective utility (it is never simply “money”). And of course we want to make most out of what we invest in terms of time and resources! That is, after all, how we choose.
The question is not really about this assumption, which is indeed tautological (this means it follows strictly logically from the assumptions, which are shown to be true), but the practical implications. We all understand that we can learn to make wiser choices, to improve our judgment, and learn to better anticipate implications and consequences of actions. So we’re not born with perfect knowledge, we’re ignorant. This is where the economist comes in, who with his or her understanding of the economy and its laws (economic laws, not enacted man-made law) – economic reasoning – can help clarify the reasoning and identify whether certain outcomes are reasonable to expect, if there are problems we have not considered, etc.
In other words, we always maximize profits, but can learn to become better at estimating outcomes. This type of learning will naturally make us even better off. One thing that is often overlooked t a young age is the impact certain actions will have on other people, and how this in turn affects our estimate. Hopefully, with experience we learn how to better predict outcomes of actions in a social setting, and this makes us aware of and mere tolerant of other people’s choices. Simply because we know that short-sightedness and anti-social behavior doesn’t really benefit us in the long run. And that is, as we learn with experience, an important dimension of calculating anticipated values.
Structured, rational thinking about community, cooperation, and the market