Profit maximization

I read today David Colander’s article How to Market the Market: The Trouble with Profit Maximization and Aswath Damodaran‘s response in the most recent issue of the Eastern Economic Journal. By coincidence we’re also talking producer theory in my economics 101 class right now, so the timing is good. I favor Colander.

As the 101 story goes, profit maximization plus the assumptions of the perfectly competitive model generate maximal efficiency in the hypothetical economy. The Colander article establishes the historical context, entwined with the formal mathematical turn in economic theory and the methodological-ideological mashup of “free market” economics circa Friedman.

My feelings on the use and abuse of “efficiency” as a concept are well established. On top of this we have the evidence that learning about profit maximization induces students of economics and business to answer moral dilemmas involving hypothetical businesses differently than other people.

Something that bugs me is that I feel like “business” gets a pass on things that would never fly in other walks of life. I mean, sure United Airlines gets a justified backlash when a passenger is violently concussed on one of their flights, but the subtext is “well, yeah, they’re trying to make money.” Albert Burnenko was on to this at Deadspin after the United incident. The motives of the corporation are taken for granted to be inhuman.

In politics, behavior that would sink a typical politician a hundred times over rolls off the back of an “outsider” candidate from “the world of business”.

I struggle to think of examples from books, movies, or television in which firms, business, corporations—whatever you want to call them—are the good guys. Instead if you’re consuming the culture you’re getting a creeping collective paranoia about the callousness of the profit motive. This is what Angela Allan is getting at in this Atlantic article that I continue to assign regularly. I realize that the people who create art may have a particular perspective distinct from the average businessperson or person-on-the-street, but if culture creates and reflects itself then corporations are not the heroes of this story.

Damodaran concludes his response like so:

Implicit in that statement is the presumption that talking about private businesses making profits makes people feel queasy, a presumption which may be justified in the rarefied air of some parts of Vermont but it is not true in the rest of the world!

I don’t agree with this at all. Every semester I try to have my students think about what connotations they and their peers are carrying about “business”, “corporations”, “profit”. The connotations of “big business” are not positive. Economics is infected by association, and I know what the average person thinks of economists.

Or, more nuanced, the idea that a corporation is a callous automaton that is supposed to do whatever it can get away with to make as much profit as possible is so baked in that it doesn’t even seem like a bad thing anymore.”Of course” businesses are supposed to try to make as much money as possible, right?

On the other hand, Damodaran is quite right that there is nothing new in human suspicion of the pursuit of wealth just because economists came to adopt profit maximization into the canonical texts. It’s just another one of those aspects of our methodology that gives us a pedagogical PR problem.

I find profit maximization a lot riskier and more nefarious in econ 101 than utility maximization. It’s too real. It’s tricky enough to tease out the technical meaning of rational choice and preferences to sell utility maximization properly, but this ultimately lets profit maximization off very lightly since it doesn’t require the same technical ramping up. It just feels too obvious, and so I find myself having to work twice as hard to give it the interrogation it deserves. There’s no getting around either of them if you want to teach general equilibrium and the welfare theorems, and of course we do. I worry about the proportionality.

I also find it interesting the advent of behavioral economics has mobilized so much energy beating up on utility maximization, and the 20th century debates on profit maximization that Colander describes have given way to consensus. I think this is way out of proportion with the funkiness of the concepts. Utility maximization is abstract and flexible in way that profit maximization just is not. Profit is a real thing in the real world, very close to the model version of profit in its definition and spirit. Utility is not. Maybe we could pick the straw man of homo economicus up from under the bus, since I for one am much more relaxed about selling rationality than I am about selling profit maximization.

Microeconomics in six words

This is certainly frivolous, but in the spirit of the addictive six word memoir (see here and here), I got to wondering about the six word memoir for the traditional undergraduate Intermediate Microeconomics course. My best effort is:

“Markets work, except when they don’t.”

Intermediate Microeconomics is a course I have both taken and lectured. It’s the gateway drug to economics electives, in a way that the Principles courses I hate so well are not: it is dry and musty with terminology, calculus and diagrams. Relating student to material is the difficult part, as with all of these positivist courses. When I took the course, it was split half and half between the dry stuff and policy debates that applied it, which was perhaps a good idea.

A six word syllabus for Micro?

“People, firms, markets: now with calculus!”

The technical parts of the course are about the foundations of all scientific theoretical economics: how we can model people, how we can model firms, how we can model interactions. It builds, in my opinion, towards the two monumental political economic results in our canon, our intellectual arguments for and against markets as a resource allocation mechanism. They are the first and second theorems of welfare economics. The first one sets out the conditions under which markets will give a Pareto efficient allocation of resources, and the second one sets out the conditions which would make lossless redistribution of resources possible.

First of all, these are tremendously elegant, in the mathematical sense. Second, they are utterly unrealistic. Together, this makes them a fascinating and infuriating jumping-off point for all debate about the appropriate way to allocate resources, in specific situations and in the wider sense. They don’t answer the questions. They beg us to ask when we can do better; they beg us to ask what better even means. All philosophical, moral and political debate on economic policy bursts fractal-like from these seeds, the painstaking culmination of the “how”, the layering of the interactions of all the actors in the economy.

That’s when technicalities can become interesting. It made me want to follow those paths where they led.