Risk, Uncertainty, and Profit

Frank H. Knight
Knight, Frank H.
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First Pub. Date
Boston, MA: Hart, Schaffner & Marx; Houghton Mifflin Co.
Pub. Date
1st edition. Based on award-winning dissertation essay.

Author's Preface


There is little that is fundamentally new in this book. It represents an attempt to state the essential principles of the conventional economic doctrine more accurately, and to show their implications more clearly, than has previously been done. That is, its object is refinement, not reconstruction; it is a study in "pure theory." The motive back of its presentation is twofold. In the first place, the writer cherishes, in the face of the pragmatic, philistine tendencies of the present age, especially characteristic of the thought of our own country, the hope that careful, rigorous thinking in the field of social problems does after all have some significance for human weal and woe. In the second place, he has a feeling that the "practicalism" of the times is a passing phase, even to some extent a pose; that there is a strong undercurrent of discontent with loose and superficial thinking and a real desire, out of sheer intellectual self-respect, to reach a clearer understanding of the meaning of terms and dogmas which pass current as representing ideas. For the first of these assumptions a few words of elaboration or defense may be in place, in anticipation of the essay itself.


The "practical" justification for the study of general economics is a belief in the possibility of improving the quality of human life through changes in the form of organization of want-satisfying activity. More specifically, most projects of social betterment involve the substitution of some more consciously social or political form of control for private property and individual freedom of contract. The assumption underlying such studies as the present is that changes of this character will offer greater prospect of producing real improvement if they are carried out in the light of a clear understanding of the nature and tendencies of the system which it is proposed to modify or displace. The essay, therefore, endeavors to isolate and define the essential characteristics of free enterprise as a system or method of securing and directing coöoperative effort in a social group. As a necessary condition of success in this endeavor it is assumed that the description and explanation of phenomena must be radically separated from all questions of defense or criticism of the system under examination. By means of first showing what the system is, it is hoped that advance may be made toward discovering what such a system can, and what it cannot, accomplish. A closely related aim is that of formulating the data of the problem of economic organization, the unchangeable materials with which, and conditions under which, any machinery of organization has to work. A sharp and clear conception of these fundamentals is viewed as a necessary foundation for answering the question as to what is reasonably to be expected of a method of organization, and hence of whether the system as such is to be blamed for the failure to achieve ideal results, of where if at all it is at fault, and the sort of change or substitution which offers sufficient chance for improvement to justify experimentation.


The net result of the inquiry is by no means a defense of the existing order. On the contrary, it is probably to emphasize the inherent defects of free enterprise. But it must be admitted that careful analysis also emphasizes the fundamental difficulties of the problem and the fatuousness of over-sanguine expectations from mere changes in social machinery. Only this foundation-laying is within the scope of this study, or included within the province of economic theory. The final verdict on questions of social policy depends upon a similar study of other possible systems of organization and a comparison of these with free enterprise in relation to the tasks to be accomplished. This one "conclusion" may be hazarded, that no one mode of organization is adequate or tolerable for all purposes in all fields. In the ultimate society, no doubt, every conceivable type of organization machinery will find its place, and the problem takes the form of defining the tasks and spheres of social endeavor for which each type is best adapted.


The particular technical contribution to the theory of free enterprise which this essay purports to make is a fuller and more careful examination of the rôle of the entrepreneur or enterpriser, the recognized "central figure" of the system, and of the forces which fix the remuneration of his special function. The problem of profit was suggested to the writer as a suitable topic for a doctoral dissertation in the spring of 1914 by Dr. Alvin Johnson, then Professor of Economics in Cornell University. The study was chiefly worked out under the direction of Professor Allyn A. Young after Dr. Johnson left Cornell. My debt to these two teachers I can only gratefully acknowledge. Since the acceptance of the essay as a thesis at Cornell in June, 1916, and its submission in the Hart, Schaffner & Marx competition in 1917, it has been entirely rewritten under the editorial supervision of Professor J. M. Clark, of the University of Chicago. I have also profited much by discussions with Professor C. O. Hardy, my colleague at the same institution, and by access to his unpublished "Readings on Risk and Risk-Bearing." Professor Jacob Viner, of the University of Chicago, has kindly read the proof of the entire work. My obligations to various economists through their published work are very inadequately shown by text and footnote references, but are too comprehensive and indefinite to express in detail.

Iowa City, Iowa
January, 1921

Part I


Part I, Chapter I

The Place of Profit and Uncertainty in Economic Theory


Economics, or more properly theoretical economics, is the only one of the social sciences which has aspired to the distinction of an exact science. To the extent that it is an exact science it must accept the limitations as well as share the dignity thereto pertaining, and it thus becomes like physics or mathematics in being necessarily somewhat abstract and unreal. In fact it is different from physics in degree, since, though it cannot well be made so exact, yet for special reasons it secures a moderate degree of exactness only at the cost of much greater unreality. The very conception of an exact science involves abstraction; its ideal is analytic treatment, and analysis and abstraction are virtually synonyms. We have given us the task of reducing to order a complex mass of interrelated changes, which is to say, of analyzing them into uniformities of sequence or behavior, called laws, and the isolation of the different elementary sequences for separate study.


Sometimes the various elementary constituents of our complex phenomenon are met with in nature in isolation complete or partial, and sometimes artificial experiments can be devised to present them either alone or with attendant conditions subject to control. The latter is, of course, the characteristic procedure of physical science. Its application to the study of industrial society is, however, generally impracticable. Here we must commonly search for manifestations of the various factors in our complex, under varying associations, or rely upon intuitive knowledge of general principles and follow through the workings of individual chains of sequence by logical processes.


The application of the analytic method in any class of problems is always very incomplete. It is never possible to deal in this way with a very large proportion, numerically speaking, of the vast complexity of factors entering into a normal real situation such as we must cope with in practical life. The value of the method depends on the fact that in large groups of problem situations certain elements are common and are not merely present in each single case, but in addition are both few in number and important enough largely to dominate the situations. The laws of these few elements, therefore, enable us to reach an approximation to the law of the situation as a whole. They give us statements of what "tends" to hold true or "would" hold true under "ideal" conditions, meaning merely in a situation where the numerous and variable but less important "other things" which our laws do not take into account were entirely absent.


Thus, in physics, the model and archetype of an exact science of nature, a relatively small and workable number of laws or principles tell us what would happen if simplified conditions be assumed and all disturbing factors eliminated. The simplified conditions include specifications as to dimensions, mass, shape, smoothness, rigidity, elasticity and properties generally of the objects worked with, specifications usually quite impossible to realize in fact, yet absolutely necessary to make, while the "disturbing factors" are simply anything not included in the specifications, and their actual elimination is probably equally impossible to realize, and, again, equally necessary to assume. Only thus could we ever obtain "laws," descriptions of the separate elements of phenomena and their separate behavior. And while such laws, of course, never accurately hold good in any particular case, because they are incomplete, not including all the elements in the case, yet they enable us to deal with practical problems intelligently because they are approximately true and we know how to discount their incompleteness. Only by such approximations, reached by dealing analytically with the more important and more universal aspects of phenomena, could we ever have attained any intelligent conception of the behavior of masses of matter in motion and secured our present marvelous mastery over the forces of nature.


In a similar way, but for various reasons not so completely and satisfactorily, we have developed a historic body of theoretical economics which deals with "tendencies"; i.e., with what "would" happen under simplified conditions never realized, but always more or less closely approached in practice. But theoretical economics has been much less successful than theoretical physics in making the procedure useful, largely because it has failed to make its nature and limitations explicit and clear. It studies what would happen under "perfect competition," noting betimes respects in which competition is not perfect; but much remains to be done to establish a systematic and coherent view of what is necessary to perfect competition, just how far and in what ways its conditions deviate from those of real life and what "corrections" have accordingly to be made in applying its conclusions to actual situations.*1


The vague and unsettled state of ideas on this subject is manifest in the difference of opinion rife among economists as to the meaning and use of theoretical methods. At one extreme we have mathematical economists and pure theorists*2 to whom little if anything outside of a closed system of deductions from a very small number of premises assumed as universal laws is to be regarded as scientific economics at all. At the other extreme there is certainly a strong and perhaps growing tendency to repudiate abstraction and deduction altogether, and insist upon a purely objective, descriptive science. And in between are all shades of opinion.


In the present writer's view the correct "middle way" between these extreme views, doing justice to both, is not hard to find. An abstract deductive system is only one small division of the great domain of economic science, but there is opportunity and the greatest necessity for cultivating that field. Indeed, in our analogy, theoretical mechanics is a very small section of the science of physical nature; but it is a very fundamental section, in a sense the "first" of all, the foundation and prerequisite of those that follow. And this also may very well hold good of a body of "pure theory" in economics; it may be that a small step, but the first step, toward a practical comprehension of the social system is to isolate and follow out to their logical conclusion a relatively small number of fundamental tendencies discoverable in it. There is abundant need for the use of both deduction and induction in economics as in other sciences, if indeed the two methods are theoretically separable. As Mill has well argued*3 we must reason deductively as far as possible, always collating our conclusions with observed facts at every stage. Where the data are too complex to handle in this way induction must be applied and empirical laws formulated, to be connected deductively with the general principles of "ethology" (we should now say simply "human behavior"). Emphasis being laid on the provisos, in both cases, that in using deduction the conclusions must be constantly checked with facts by observation and premises revised accordingly, while the empirical laws resulting from induction must in turn be shown to follow from the general principles of the science before they can be credited with much significance or dependability, we see that there is little divergence left between the two methods.*4


The method of economics is simply that of any field of inquiry where analysis is in any degree applicable and anything more than mere description possible. It is the scientific method, the method of successive approximations.*5 The study will begin with a theoretical branch dealing with only the most general aspects of the subject matter, and proceed downward through a succession of principles applicable to more and more restricted classes of phenomena. How far the process is carried will be a matter of taste and of the practical requirements of any problem. In science generally it does not pay to elaborate laws of a very great degree of accuracy of detail. When the number of factors taken into account in deduction becomes large, the process rapidly becomes unmanageable and errors creep in, while the results lose in generality of application more significance than they gain by the closeness of approximation to fact in a given case. It is better to stop dealing with elements separately before they get too numerous and deal with the final stages of the approximation by applying corrections empirically determined.


The theoretical method in its pure form consists, then, in the complete and separate study of general principles, with the rigid exclusion of all fluctuations, modifications, and accidents of all sorts due to the influence of factors less general than those under investigation at any particular stage of the inquiry. Our question relates to the advisability of using this method in a tolerably rigid form in economics. The answer to this question depends on whether in the phenomena to be studied general principles can in fact be found of sufficient constancy and importance to justify their careful isolation and separate study. The writer is strongly of the opinion that the question must be answered affirmatively. Economics is the study of a particular form of organization of human want-satisfying activity which has become prevalent in Western nations and spread over the greater part of the field of conduct. It is called free enterprise or the competitive system. It is obviously not at all completely or perfectly competitive, but just as indisputably its general principles are those of free competition. Under these circumstances the study, as a first approximation, of a perfectly competitive system, in which the multitudinous degrees and kinds of divergences are eliminated by abstraction, is clearly indicated. The method is particularly indicated in a practical sense because our most important questions of social policy hinge directly upon the question of the character of the "natural" results of competition, and take the form of queries as to whether the tendencies of competition are to be furthered and supplemented or obstructed and replaced.


That such a theoretical first approximation is indicated in a theoretical sense, that it is the natural logical way of going at the problem, conforming to the workings of our thought processes, is sufficiently evidenced by the fact that this is what economists have always in fact done, ever since there has been such a science or such a social system to be studied. They have, to be sure, been criticized for doing it, and severely. But in the present writer's judgment theorists of the past and present are to be justly criticized not for following the theoretical method and studying a simplified and idealized form of competitive organization, but for not following it in a sufficiently self-conscious, critical, and explicit way. In their discussions of methodology the historic economists have, indeed, been as clear and explicit as could be desired,*6 but in the use of the method as much cannot, unfortunately, be said.


It should go without saying that in the use of the scientific method of reasoning from simplified premises, it is imperative that it be clear to the reasoner and be made unmistakable to those who use his work what his procedure is and what presuppositions are involved. Two supreme difficulties have underlain controversies regarding method in the past. The first is the strong aversion of the masses of humanity, including even a large proportion of "scholars," to all thinking in general terms. The second difficulty, on the other side, is the fact referred to above, that the persons employing methods of approximation in economics have not themselves adequately and always recognized, and still less have they made clear to their readers, the approximate character of their conclusions, as descriptions of tendency only, but have frequently hastened to base principles of social and business policy upon very incomplete data. The evil results of the failure to emphasize the theoretical character of economic speculation are apparent in every field of practical economics. The theorist not having definite assumptions clearly in mind in working out the "principles," it is but natural that he, and still more the practical workers building upon his foundations, should forget that unreal assumptions were made, and should take the principles over bodily, apply them to concrete cases, and draw sweeping and wholly unwarranted conclusions from them. The clearly untenable and often vicious character of such deductions naturally works to discredit theory itself. This, of course, is wrong; we do not allow perpetual motion schemes to discredit theoretical mechanics, which is built upon the assumption of perpetual motion at every stage. But in economics a distrust of general principles, fatal as it is to clear thinking, will be inevitable as long as the postulates of theory are so nebulous and shifting. They can hardly be made sufficiently explicit; it is imperative that the contrast between these simplified assumptions and the complex facts of life be made as conspicuous and as familiar as has been done in mechanics.


The present essay is an attempt in the direction indicated above. We shall endeavor to search out and placard the unrealities of the postulates of theoretical economics, not for the purpose of discrediting the doctrine, but with a view to making clear its theoretical limitations. There are several reasons why the approximate character of theoretical economic laws and their inapplicability without empirical correction to real situations should be especially emphasized as compared, for instance, with those of mechanics. The first reason is historical and has already been indicated. The limitations of the results have not always been clear, and theorists themselves as well as writers in practical economics and statecraft have carelessly used them without regard for the corrections necessary to make them fit concrete facts. Policies must fail, and fail disastrously, which are based on perpetual motion reasoning without the recognition that it is such.


In the second place, the allowances and corrections necessary in the case of theoretical economics are vastly greater than in the case of mechanics, and the importance of not losing sight of them is correspondingly accentuated. The general principles do not bring us so close to reality; there is a larger proportion of factors in an economic situation which are of the variable and fluctuating sort.


Again, in spite of the greater contrast between theory and practice in the study of the mechanics of competition, as compared with the mechanics of matter and motion, the contrast is less familiar and more easily overlooked. Our race has been observing and handling in a rude way the latter type of phenomena ever since it has lived on the earth, while competitive relations among men were established only a few generations ago. In consequence the habit of clear thinking according to scientific method, the use of hypotheses and separation of fundamental principles from the accidents of particular instances, has become in some measure built up in the minds of at least a respectable body of the more cultivated division of the race. Perhaps it is even in some degree instinctive in certain strains.*7


Finally, it makes vastly more difference practically whether we disseminate correct ideas among the people at large in the field of human relations than is the case with mechanical problems. For good or ill, we are committed to the policy of democratic control in the former case, and are not likely to resort to it in the latter. As far as material results are concerned, it is relatively unimportant whether people generally believe in their hearts that energy can be manufactured or that a cannon ball will sink part of the way to the bottom of the ocean and remain suspended, or any other fundamental misconception. We have here at least established the tradition that knowledge and training count and have persuaded the ignorant to defer to the judgment of the informed. In the field of natural science the masses can and will gladly take and use and construct appliances in regard to whose scientific basis they are as ignorant as they are indifferent. It is usually possible to demonstrate such things on a moderate scale, and literally to knock men down with "results." In the field of social science, however, fortunately or unfortunately, these things are not true. Our whole established tradition tends to the view that "Tom, Dick, and Harry" know as much about it as any "highbrow"; the ignorant will not in general defer to the opinion of the informed, and in the absence of voluntary deference it is usually impossible to give an objective demonstration. If our social science is to yield fruits in an improved quality of human life, it must for the most part be "sold" to the masses first. The necessity of making its literature not merely accurate and convincing, but as nearly "fool-proof " as possible, is therefore manifest.


Whether or not the use of the method of exact science is as necessary in the field of social phenonena as the present writer believes, it will doubtless be conceded; even by opponents of this view, that it has been employed in the great mass of the literature since the modern science of economics was founded. It may also be granted that the terminology, concepts, and modes of thinking in our economic instruction and in general discussion are and for a long time must be largely dominated by the established tradition. And it will certainly not be denied that if the method of reasoning from hypothetical or simplified premises is followed, its use must be thoroughly safeguarded by emphasizing the character of the premises and the consequent conditional or approximate validity of the conclusions reached. If, finally, it is admitted that this has not been adequately done hitherto, and that mischief and misunderstanding have followed from the loose use of assumptions and looser application of conclusions, then the call for such a study as the present will be established.


The tendency toward a sharper separation of the theoretical portion of economics from the empirical portion, and toward the clearer formulation of premises, can be traced in the literature of the subject, and notable progress in the right direction has recently been made. The work of the mathematical economists and non-mathematical pure theorists has already been mentioned. A considerable and fairly satisfactory body of consciously and rigidly "theoretical" (i.e., general and approximate) doctrine has been built up. The work of Pareto and Wicksteed seems to the writer especially worthy of note. Unfortunately it has not achieved the recognition and been accorded the fundamental place in the general program of the science which we think it should have; mathematical economics in particular seems likely to remain little more than a cult, a closed book to all except a few of the "initiated." In the great mass of economic literature there is certainly still wanting the evidence of a comprehensive grasp of general principles and even more of the meaning and importance of general principles in a scientific program. There is still a need for thoroughgoing and critical comparison and contrast of theoretical assumptions with the conditions of real life and of theoretical conclusions with concrete facts. The makers and users of economic analysis have in general still to be made to see that deductions from theory are necessary, not because literally true—that in the strict sense they are useful because not literally true—but only if they bear a certain relation to literal truth and if all who work with them constantly bear in mind what that relation is. It must be admitted that even the pure theorists have not generally been assiduous in emphasizing the practical significance of their work and its relation to the outside body of the science; they have been too exclusively interested in the construction of their a priori systems, and perhaps a little disposed to regard these as a disproportionate part of economic science. Such a bias is natural and even useful, but in a field where the relations between theory and practice do not come instinctively to the minds of the users of both, the supplementation of theory by works of interpretation becomes indispensable.


Indication of progress in this field is furnished especially by the discussion centering around the concept of normality in the work of Marshall in England and the related notion of the static state espoused in particular in this country by J. B. Clark.*8 The meaning and bearings of the fundamental concepts are in the writer's opinion much better worked out by Marshall than by any other writer generally read. But Marshall himself has adopted a cautious, almost anti-theoretical attitude toward fundamentals; he refuses to lay down and follow rigidly defined hypotheses, but insists on sticking as closely as possible to concrete reality and discussing "representative" conditions as opposed to limiting tendencies. The gain in concreteness and realism is in our opinion much more than offset by the obscurity, vagueness, and unsystematic character of the discussion, the inevitable consequence of burying fundamentals in an overwhelming mass of qualification and detail. Professor Clark, on the other hand, is frankly theoretical and insistent upon the deliberate use of abstraction. But the writer at least is unable to agree with him on the question of what abstractions should be made and the manner of their use. While the specifications for his theoretical state are more definite and explicit than those of Marshall, they seem to us less correctly drawn up.*9


The opposition to pure theory in general is based on a failure to understand it, and especially common is the misconception as to the meaning of static or normal hypotheses. It is not recognized that their use is inherent in the methodology of science, is in fact the very essence of scientific procedure; that it is not at all recondite or intellectual in its appeal, but is mere practical common sense. The aim of science is to predict the future for the purpose of making our conduct intelligent.*10 Intelligence predicts, as shown above, through analysis, by isolating the different forces or tendencies in a situation and studying the character and effects of each separately. Static method and reasoning are therefore coextensive. We have no way of discussing a force or change except to describe its effects or results under given conditions.


The "static" method in economics does merely this. It inquires what conditions exist and studies the results which recognizable forces at work (or changes in progress—we know nothing about force; it is the assumed "cause" of change, which is the only fact) tend to produce under those conditions. It is "unreal" only in the simplification of its problem; i.e., in taking the more conspicuous forces and more important conditions and provisionally neglecting others. This the limitations of our minds compel us to do. We must first discuss one change at a time, assuming the others suspended while that one is working itself out to its final results, and then attempt to combine the tendencies at work, estimate their relative importance, and make actual predictions. This is the way our minds work; we must divide to conquer. Where a complex situation can be dealt with as a whole—if that ever happens—there is no occasion for "thought." Thought in the scientific sense, and analysis, are the same thing.


The reference to final results calls for a further word. The concept of equilibrium is closely related to that of static method. It is the nature of every change in the universe known to science to have "final" results under any given conditions, and the description of the change is incomplete if it stops short of the statement of these ultimate tendencies. Every movement in the world is and can be clearly seen to be a progress toward an equilibrium. Water seeks its level, air moves toward an equality of pressure, electricity toward a uniform potential, radiation toward a uniform temperature, etc. Every change is an equalization of the forces which produce that change, and tends to bring about a condition in which the change will no longer take place. The water continues to flow, the wind to blow, etc., only because the sun's heat—itself a similar but more long-drawn-out redistribution of energy—constantly restores the inequalities which these movements themselves constantly destroy.


So also in economic phenomena. Goods move from the point of lower to one of higher demand or price, and every such movement obliterates the price difference which causes it. The circulation of goods continues because the life activities of man (the production of wealth) keep new supplies forthcoming. The same applies to shifts in productive energy from one use to another. There are really as many static states as there are changes to be studied, sets of given conditions to be assumed. It is arbitrary but convenient to speak of the static state in relation to given conditions of the supply and demand (production and consumption) of consumption goods. We shall see that there are in fact two other fundamental static problems; the first assumes given supplies of consumption goods, and the second, given general conditions under which the creation of production goods and changes in wants take place; the first is the problem of the market or of market price, and the second that of social economic progress, often referred to as economic dynamics.


The argument of the present essay will center around the general idea of normality, viewed as an attempt to isolate for study the essentials or general principles of a competitive social economic organization. The aim will be to bring out the content of the assumptions or hypotheses of the historic body of economic thought, referred to by the classical writers as "natural price" theory. By this is meant, not the assumptions definitely in the minds of the classical economists, but the assumptions necessary to define the conditions of perfect competition, at which the classical thought was aimed, and which are significant as forming the limiting tendency of actual economic processes.*11


As the title of the essay indicates, our task will be envisaged from the immediate standpoint of the problem of profit in distributive theory. The primary attribute of competition, universally recognized and evident at a glance, is the "tendency" to eliminate profit*12 or loss, and bring the value of economic goods to equality with their cost. Or, since costs are in the large identical with the distributive shares other than profit, we may express the same principle by saying that the tendency is toward a remainderless distribution of products among the agencies contributing to their production. But in actual society, cost and value only "tend" to equality; it is only by an occasional accident that they are precisely equal in fact; they are usually separated by a margin of "profit," positive or negative. Hence the problem of profit is one way of looking at the problem of the contrast between perfect competition and actual competition.


Our preliminary examination of the problem of profit will show, however, that the difficulties in this field have arisen from a confusion of ideas which goes deep down into the foundations of our thinking. The key to the whole tangle will be found to lie in the notion of risk or uncertainty and the ambiguities concealed therein. It is around this idea, therefore, that our main argument will finally center. A satisfactory explanation of profit will bring into relief the nature of the distinction between the perfect competition of theory and the remote approach which is made to it by the actual competition of, say, twentieth-century United States; and the answer to this twofold problem is to be found in a thorough examination and criticism of the concept of Uncertainty, and its bearings upon economic processes.


But Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The term "risk," as loosely used in everyday speech and in economic discussion, really covers two things which, functionally at least, in their causal relations to the phenomena of economic organization, are categorically different. The nature of this confusion will be dealt with at length in chapter VII, but the essence of it may be stated in a few words at this point. The essential fact is that "risk" means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomenon depending on which of the two is really present and operating. There are other ambiguities in the term "risk" as well, which will be pointed out; but this is the most important. It will appear that a measurable uncertainty, or "risk" proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all. We shall accordingly restrict the term "uncertainty" to cases of the non-quantitive type. It is this "true" uncertainty, and not risk, as has been argued, which forms the basis of a valid theory of profit and accounts for the divergence between actual and theoretical competition.


As a background for the discussion of the meaning and causal relations of uncertainty, we shall first make a brief survey of previously proposed theories of profit. After a summary glance at the history of the treatment of the subject down to recent decades, it will be necessary to dwell at slightly greater length upon the controversy recently carried on in connection with the explanation of profit in terms of risk. The crucial character of the distinction between measurable risk and unmeasurable uncertainty will become apparent in this discussion.


Part Two (chapters III-VI) will be taken up with an outline study of a theoretical, perfectly competitive society. In the course of the argument it will become increasingly evident that the prime essential to that perfect competition which would secure in fact those results to which actual competition only "tends," is the absence of Uncertainty (in the true, unmeasurable sense). Other presuppositions are mostly included in or subordinate to this, that men must know what they are doing, and not merely guess more or less accurately. The "tendency" toward perfect competition is at once explained, since men are creatures endowed with the capacity to learn, and tend to find out the results of their acts, while the cause of the failure ever to reach the goal is equally evident so long as omniscience remains unattainable. Now since risk, in the ordinary sense, does not preclude perfect planning (for reasons which can easily be made clear), such risk cannot prevent the complete realization of the tendencies of competitive forces, or give rise to profit.


At the conclusion of this brief treatment of perfect competition we shall devote a short chapter to limitations of perfect competition other than the imperfection of knowledge, and then take up in Part Three a careful analysis of the concepts of Risk and Uncertainty (chapter VII), proceeding (in the remaining chapters) with a somewhat detailed study of the effects of both, but especially of true or unmeasurable uncertainty upon the economic organization and of its bearings upon economic theory. The economic relations of risk in the narrower sense of a measurable probability have been extensively dealt with in the literature of the subject and do not call for elaborate treatment here. Our main concern will be with the contrast between Risk as a known chance and true Uncertainty, and treatment of the former is incidental to this purpose.

Notes for this chapter

Cf. Mackenzie, Introduction to Social Philosophy, p. 58. Also Bagehot, Economic Studies, no. 1: "The Presuppositions of English Political Economy."
There are three types or schools of mathematical economic theory, connected with the names of Cournot, Jevons, and Walras respectively. Dr. Vilfredo Pareto, of the University of Lausanne (successor of Walras), is now the most prominent exponent of the mathematical method. Among "literary" pure theorists, Wicksteed, Schumpeter, and Pantaleoni stand out.
Logic, book VI, chaps. IX and X.
The relations between deduction and induction are intimate, and a rigid separation or contrast between the two methods is misleading. A more careful study of the fundamentals of scientific method will be undertaken hereafter (chapter VII). We shall see that there is ultimately no such fact as deduction as commonly understood, that inference is from particulars to particular, and that generalization is always tentative and a mere labor-saving device. The fact is, however, that we can study facts intelligently and fruitfully only in the light of hypotheses, while hypotheses have value more or less in proportion to the amount of antecedent concrete knowledge of fact on which they are based. The actual procedure of science thus consists of making and testing hypotheses. The first hypotheses in any field are usually the impressions of "common sense"; i.e., of that superficial knowledge forced upon intelligence by direct contact with the world. Study, in the light of any hypothesis, corrects or refutes the guiding generalization and suggests new points of view, to be criticized and tested in the same way, and so the organization of the material proceeds. The importance of generalization arises from the fact that as our minds are built, it is nearly fruitless to attempt to observe phenomena unless we approach them with questions to be answered. This is what a hypothesis really is, a question. Superficial observation suggests questions which study answers. If and so long as it answers a question affirmatively and the answer is not contradicted by the test of practical application or casual observation, we have a law of nature, a truth about our environment which enables us to react intelligently to it in our conduct.

There is, then, little if any use for induction in the Baconian sense of an exhaustive collection and collation of facts, though in some cases this may be necessary and fruitful. On the other hand, there is equally little use for deduction taken as doing more than suggesting hypotheses, subject to verification. It is to be noted, however, that our common-sense generalizations have a very high degree of certainty in some fields, giving us, in regard to the external world, for instance, the "axioms" of mathematics. Even more important in the present connection is the rôle of common sense or intuition in the study of human phenomena. Observation and intuition are, indeed, hardly distinguishable operations in much of the field of human behavior. Our knowledge of ourselves is based on introspective observation, but is so direct that it may be called intuitive. Its extension to our fellow human beings is also based upon the interpretation of the communicative signs of speech, gesture, facial expression, etc., far more than upon direct observation of behavior, and this process of interpretation is highly instinctive and subconscious in character. Many of the fundamental laws of economics are therefore properly "intuitive" to begin with, though of course always subject to correction by induction in the ordinary sense of observation and statistical treatment of data.

These brief statements must not be thought of as dealing with philosophical problems. The writer is, like Mill, an empiricist, holding that all general truths or axioms are ultimately inductions from experience. By induction as a method is meant deliberate, scientific induction, the planned study of instances for the purpose of ascertaining their "law." And deduction means reaching new truth by the application of general laws to particular cases. In the present view both of these processes are regarded as suggestive merely, exhaustive induction and conclusive deduction being alike impossible.

The reader will recall Comte's arrangement of the sciences in the order of generality of the principles they establish. Mathematics, the properties of space and of quantity in the abstract, is applicable to all phenomena—and tells us correspondingly little about any of them. The laws of matter, of living matter, etc., are less general and more concretely real. The same principles are applicable within any grand division of knowledge.
Cf. Mill's Essays on Unsettled Questions, no. 5, which really leaves little to be said on the subject. Also Cairnes, on the Character and Logical Method of Political Economy, and the discussions of methodology of the English economists generally. The conception of the "economic man" was one way of emphasizing the abstract and simplified character of the premises of the science. Keynes's Scope and Logical Method of Political Economy is as ably clear and conclusive discussion of this whole subject.
It is necessary to admit that in fact only a pitifully small fraction of the race have any particular theoretical sense in the mechanical field either. Certainly a vast majority of literate adults with elementary experience with machinery have no real comprehension of the most fundamental principles of the transformation and equivalence of forces. As far as their own insight is concerned, they could easily be taken in with crude perpetual motion schemes, and an astonishing proportion are willing to back their own judgment in such matters against what they know to be the unanimous verdict of the scientific world. The recurrent discussion of such projects in our National Congress are familiar. A certain mechanical "handiness" is probably all that is to be found in any but the rare scientific minds, and these handy men are precisely the ones who seem most likely to waste their lives and means over palpably absurd enterprises. A large proportion even of competent engineers have neither comprehension nor appreciation of physical theory.
The static state idea is further developed along rigidly theoretical lines by Professor Schumpeter in Austria.
We shall attempt to show that it does not represent, as Professor Clark contends, the assumptions implicit in the classical economic theory. (See chapter II.)
Cf. Dewey's definition of reason as the method of social diagnosis and prognosis.
We need not here more than mention the obvious fact that the theoretical method is applicable to monopoly as well as competition and has dealt with both. It has been, of course, a theoretically "ideal" monopoly also—the real assumption being an exceptional instance of perfect monopoly in a general system of perfect competition. The contrast between theory and reality and the significance of the former is of the same sort in both cases, and we shall also discuss the meaning of perfect monopoly in the proper connection. (Chapter VI.)
It will be perceived that the word "profit" is here used in the sense of "pure profit, a distributive share different from the returns to the productive services of land, labor, and capital.

Part I, Chapter II.

End of Notes

Part I, Chapter II

Theories of Profit;*13
Change and Risk in Relation to Profit


In view of the facts set forth in the introductory chapter as to the relation of profit to theoretical economics, and the vagueness in the minds of economic writers as to fundamental postulates, it is not surprising that the theory of profit has remained one of the most unsatisfactory and controversial divisions of economic doctrine. Considering, however, the universal recognition of the "tendency" of competition to eliminate profit, it is perhaps somewhat remarkable that the problem of profit itself has not, with one important exception,*14 been attacked from the direct point of view adopted in this essay, of an inquiry into the causes of the failure of ideal competition to be fully realized in fact. It is, indeed, only within comparatively recent years that the existence of profit as a really distinct share has become established and the problem of its explanation given definite status.


As in the case of most sciences whose subject matter is some field of human activity, economic theory has been much influenced by practice, and in particular the loose use of terms in everyday affairs has given rise to serious confusions in terminology. The concept of profit is bound up in a certain type of organization of industry, a type realized in various degrees in different places and times, and always undergoing modification and development.


At the time when the English classical school of economists were writing—i.e., in the later eighteenth and early nineteenth centuries—corporations were relatively unimportant, being practically restricted to a few banks and trading companies. There was, of course, some lending at interest, but in the dominant form of industry men used their own capital, hiring labor, and renting land from others. The managerial function centered in the capitalist. Moreover, English industries were new and rapidly expanding; competition was not highly developed; the possession of capital seemed to be and was the dominant factor in the situation. Only in more recent times has the accumulation of capital, the perfection of financial institutions, and the growth of competition transferred the center of interest to business ability, made it easy or at least generally possible for ability to secure capital when not in possession of it by direct ownership, and made common the carrying-on of business predominantly with borrowed resources.


Under these early conditions it was natural to connect the income of the business manager with the ownership of capital, and in all the classical writings we find the word "profit" used in this sense. A further source of confusion was the indefiniteness of the conception and use of the ideas of natural and market price in the minds of the early writers. It is natural and inevitable that a distinction which goes to the heart of the fundamental problems of the nature and methodology of economic science should be but imperfectly worked out in the initial stages of the speculation. Only recently, again, has the analysis of long-time normal price by Marshall and of the "static state" by Clark and Schumpeter begun to give to economists a clearer notion of what is really involved in "natural" or normal conditions. To the earlier classical writers this obscurity hid the fundamental difference between the total income of the capitalist manager and contract interest. The only separation considered necessary in the explanation of distribution was to restrict the theory of the business manager's income to the explanation of "normal profit," which was regarded as substantially equivalent to contract interest. Another barrier to the formulation of a clear statement of the relations between interest and profit was the lack of an adequate understanding of the productivity of capital, which also these authors did not possess and which has first been worked out in recent years.


The qualification of "near" or "substantial" identification of normal profit and interest is necessary, however, in referring to the classical treatments. Even Adam Smith and his immediate followers recognized that profits even normally contain an element which is not interest on capital. Remuneration for the work and care of supervising the business was always distinguished. Reference was also made to risk, but in the sense of risk of loss of capital, which does not clearly distinguish profit from interest.*15 Adam Smith is explicit in regard to these elements, while Malthus and M'Culloch were more so. J. S. Mill pointed out in a somewhat groping way that the wages of management are determined in a different way from other wages, and noted also that profits, so called, include as a third element a payment for risk, as well as wages of management (and interest). The inclusion of interest in profit was opposed by Bagehot, and in the United States by Walker, but the use of the term is still somewhat loose in England, as is seen in Marshall. Even in this country the development of corporation accounting, while separating wages of management from profit, has tended to a new confusion of profit and interest.


The early French writers, beginning with J. B. Say, adopted a different view of profit, or at least a different use of the word, insisting on a separation of profit from interest and defining the former explicitly as a wage. The difference in procedure may have been due, as v. Mangoldt suggests,*16 to the different character of typical French industry and the greater importance of the manager's personality in it relatively to the capital factor. It is worthy of note that in the fourth edition of his "Traité," Say included in profit the reward for risk-taking; he had in the earlier editions viewed this income as accruing to the capitalist as such, but now transferred it to the entrepreneur. Especial mention should be made of Courcelle-Seneuil, who insisted that profit is not a wage, but is due to the assumption of risk.*17


The older German economists varied widely in their treatment of profits. Some, of whom Schäffle is perhaps the most notable example, follow the "English" view in classing profit as essentially a return to capital. Others, notably Roscher, adopt the "French"*18 attitude and treat it as a form of wages. Roscher does not even use the term "profit," but substitutes Unternehmerlohn. Other writers, such as Hermann and Rau, took a more or less intermediate position.


Still another group, of more importance for our purposes, contended that profit should be recognized as a unique form of income, not susceptible of reduction to remuneration for either capital or labor. This position was taken in a somewhat timid way by Hufeland*19 and more definitely by Riedel,*20 but its most notable advocates were Thünen and v. Mangoldt. Thünen's great work, "Der Isolirte Staat,"*21 defines profit as what is left after (a) interest, (b) insurance, and (c) wages of management, are met. This residuum consists of two parts: (1) payment for certain risks, especially changes in values and the chance of failure of the whole enterprise, which cannot be insured against, and (2) the extra productivity of the manager's labor due to the fact that he is working for himself, his "sleepless nights" when he is planning for the business. Thünen called these elements respectively Industriebelohnung and Unternehmergewinn, and their sum Gewerbsprofit.


A most careful and exhaustive analysis of profit is contained in the monograph of H. v. Mangoldt, already referred to. Proceeding on the basis of an elaborate classification of the forms of industrial organization and a discussion of the economic advantages of the entrepreneur form, this writer finds in the income of the business enterpriser a complex group of unique elements. He divides it first into three parts: (1) a premium on those risks which are of such a nature that he cannot shift them by insurance; (2) entrepreneur interest and wages, including only payments for special forms of capital or productive effort which do not admit of exploitation by any other than their owner; (3) entrepreneur rents. These last again fall into four subdivisions: (a) capital rents, (b) wage rents, (c) large enterprise rent, and (d) "entrepreneur rent in the narrower sense." They are all due to the limitation of special capacities or characteristics (the last to special combinations of such) and are called "premiums on scarcity" (Seltenheits prämeien). This is, of course, a question-begging term (though many writers have used it) since all incomes depend in the same way on the limitation of the agencies to which they are imputed. It would seem that every imaginable source of income is included in this minute and subtle classification.


A special place in the history of theories of profit should be given to the German socialist school, the so-called "scientific" socialists, Rodbertus, Marx, Engels, Lassalle, and their followers. These writers take the English classical treatment of profit in a narrowly literal (one must say wholly uncritical and superficial) sense as including all income accruing to capital, to which they add land. Combining this with an equally blind reading of the labor theory of value which was the starting-point of Smith and Ricardo, they derive a simple classification of income in which all that is not wages is a profit which represents exploitation of the working classes. Capital is equivalent to property, which is to be regarded as mere power over the economic activities of others due to the strategic position of ownership over the implements of labor. It is analogous to a robber baron's crag, a toll-gate on a natural highway, or a political franchise to exploit. Pierstorff, in the monograph referred to above, follows Rodbertus in the main, after criticizing alternative views.*22


After the publication in 1871 of Menger's "Grundsätze" had given a new interest and new turn to value theory in Austria and Germany, a notable series of discussions of profit appeared in those countries. Those calling for especial mention are the monographs of Gross*23 and Mataja*24 and the treatments by Mithoff*25 and Kleinwächter*26 in Schönberg's "Handbuch," the last-named elaborated in the author's book already referred to. Gross takes as his starting-point the plain fact that profit is the difference between the cost of goods and their value, and studies the position of the entrepreneur in the two markets in which he buys productive services and raw materials and sells his finished product. He may be said to reduce profit to bargaining power, in which, of course, superior knowledge and foresight are recognized as playing a large part, but Gross does not work out a systematic treatment of the nature and significance of risk or uncertainty. He thinks an income which is a premium for taking risks is inherently impossible, as gains and losses would necessarily balance. Few other writers agree with this proposition. Socially, profit is for Gross the inducement to follow closely the economic law of cheapest possible production and most effective utilization of goods.


Mataja's analysis of profit is a more literal application of Menger's utility theory of value. He seeks to explain price differences by means of the differences between the various uses of "goods of higher order" in making different kinds of "goods of lower order" and ultimately different consumption goods. His discussion does not get beyond a statement of the problem.


Mithoff holds that the entrepreneur's income consists of rents, wages, etc., at market rates for the productive services which he furnishes to the business, plus a "profit" which may be regarded as remuneration for taking the risk of its failure. He contends, however, that this profit is at best a mere abstraction, a complex of a number of indeterminate surpluses, and that the entrepreneur income as a whole alone has definite meaning or practical significance.


Körner is another writer who explains the entrepreneur's income in terms of superior bargaining power. His position is figured as that of a watchman on a tower and is summed up in the expression that his is a wider market than that of the men he buys from and sells to, especially the laborer whom he hires. The essential mystery of why the competition of other watchmen on similar towers does not eliminate his peculiar gain is not touched upon. The nonsocialistic German writers are usually particularly concerned to combat the allegations of the socialists and furnish a social justification of profit.


Kleinwächter views profit from the social standpoint as pay for taking the twofold risk of production—technical and economic, a distinction made by Gross—and for the care of supervision. From the individual point of view it is a speculative gain arising from advantage taken of differences between the prices of economic goods and the prices of the agents necessary to their production. In his fuller treatment in his book on distribution, Kleinwächter devotes most of his energy to a sarcastic polemic against the English classical economic theory, according to which the prices of commodities should equal their costs of production or the sum of the wages, interest, and rent paid the agents employed to produce them. No serious criticism of this theory is attempted, however, nor any sign displayed of a comprehension of its real meaning as a statement of the limits of tendencies. The general conclusion that the existence of profit follows from a divergence between the conditions of theory and those of fact is the starting-point of the present study. It is, of course, a statement of the problem, and not a solution of it; Kleinwächter virtually explains profit by ridiculing the idea that it should be thought to call for explanation.


In other than the German-speaking countries the subject of profit has not been prolific of independent monographs and treatises, but has usually been dealt with as an integral part of the general theory of distribution (though there are some exceptions in France and Italy which would have to be noticed in a fuller historical treatment). It is, of course, impossible to take up even the important theorists in all countries and summarize their views, while any brief treatment by schools or groups would be misleading rather than helpful. The writers already mentioned pretty well cover the fundamental theories and standpoints, with exceptions yet to be noted.*27 A very common procedure is to treat profit as a special case of monopoly gain, or to combine elements of monopoly position with other factors. This method is apt to degenerate into a mere confusion of the two income categories. The common use of the term "monopoly profit" to designate monopoly revenue directly incites to this confusion.


The first notable development in the field of profit theory in America was the work of General Francis A. Walker.*28 Walker effectually emphasized the place and importance of the entrepreneur or "captain of industry," and helped to free economic treatises in English from the careless handling of profit as an element in interest. His own "rent theory," however, in spite of its vogue at the time of its promulgation, need not now detain us. Walker wrote before Marshall, Clark,*29 and Hobson*30 had shown that all incomes are like rent in the mode of their determination, and with that point once made clear the rent theory is reduced to a wage theory merely, and its special significance disappears.


More recently the center of interest in the discussion of profit has shifted from Walker's theory to two other opposed views, the "dynamic theory" and the "risk theory" respectively. The former is the view upheld by Professor J. B. Clark and his followers and the latter is sponsored in particular by Mr. F. B. Hawley.*31 Neither the connection between profit and changes in conditions nor that between profit and risk is an entirely new idea, but hitherto neither had been erected into a definite and ostensibly sufficient principle of explanation of the peculiar income of the entrepreneur. These two theories call for somewhat fuller treatment.


The dynamic theory is a correlate of Professor J. B. Clark's theory of distribution in the profitless "static state."*32 Professor Clark outlines a systematic structure of theoretical economics in three main divisions.

The first treats of universal phenomena, and the second of static social phenomena. Starting with those laws of economics which act whether humanity is organized or not, we next study the forces that depend on organization but do not depend on progress. Finally it is necessary to study the forces of progress. To influences that would act if society were in a stationary state, we must add those which act only as society is thrown into a condition of movement and disturbance. This will give us a science of Social Economic Dynamics.*33


The static state is the state of "natural" adjustments of Ricardo and the early classical writers.

What are called "natural" standards of values and "natural" or normal rates of wages, interest, and profits are in reality, static rates. They are identical with those which would be realized, if a society were perfectly organized, but were free from the disturbances that progress causes.... Reduce society to a stationary state, let industry go on with entire freedom, make labor and capital absolutely mobile... and you will have a régime of natural values.*34


To realize the static state, we should have to eliminate five kinds of change which are constantly in progress:

Five generic changes are going on, every one of which reacts on the structure of society, by changing the arrangements of that group system which it is the work of catallactics to study:
1. Population is increasing.
2. Capital is increasing.
3. Methods of production are improving.
4. The forms of industrial establishments are changing, the less efficient shops, etc., are passing from the field, and the more efficient are surviving.
5. The wants of consumers are multiplying*35


In the static state each factor secures what it produces, and since cost and selling price are always equal there can be no profits beyond wages for the routine work of supervision.

The prices of goods are in these older theories said to be "natural" when they equal the cost of producing them;... in reality their "natural prices" were static prices.*36
The prices that conform to the cost of production are, of course, those which give no clear profit to the entrepreneur. A business man whose goods sell at such rates will get wages for whatever amount of labor he may perform, and interest for any capital that he may furnish; but he will have nothing more to show in the way of gain. He will sell his product for what the elements that compose it have really cost him, if his own labor and the use of his capital be counted among the costs. We shall see that this condition of no-profit prices exactly corresponds to the one that would result from the static adjustment of the producing groups.*37


Profits are, then, the result exclusively of dynamic change. "Obviously, from all these changes two general results must follow: first, values, wages and interest will differ from the static standards; secondly, the static standards themselves will always be changing."*38 The type of dynamic change is invention; "an invention makes it possible to produce something more cheaply. It first gives a profit to entrepreneurs and then... adds something to wages and interest.... Let another invention be made.... It also creates a profit; and this profit, like the first, is an elusive sum, which entrepreneurs grasp but cannot hold." It "slips through their fingers and bestows itself on all members of society."*39 Thus the effect of any one dynamic change is to produce temporary profits. But in actual society such changes constantly occur, and the readjustments are always in process. "As a result, we... have the standard of wages moving continuously upward and actual wages steadily pursuing the standard rate in its upward movement, but always remaining by a certain interval behind it."*40


In another sense profit is dependent on "friction": "The interval between actual wages and the static standard is the result of friction; for, if competition worked without let or hindrance, pure business profit would be annihilated as fast as it could be created...."*41 "Were it not for that interval, entrepreneurs as such would get nothing, however much they might add to the world's productive power."*42


The fatal criticism of this procedure of taking changes in conditions as the explanation and cause of profit is that it overlooks the fundamental question of the difference between a change that is foreseen a reasonable time in advance and one that is unforeseen. Now, if we merely assume that all the "dynamic changes" which Professor Clark enumerates, and any others which may be named, are foreknown for a sufficient time before they take place, or that they take place continuously in accordance with laws generally and accurately known, so that their course may be predicted as far into the future as occasion may require, then the whole argument based on the effects of change will fall completely to the ground. If the retort is made that this is a supposition contrary to fact and illicit, the answer is that it is only partly contrary to fact. Some changes are foreseen and some are not, the laws of some are tolerably accurately known, of others hardly at all;*43 and the variation in foreknowledge makes it clearly indispensable to separate its effects from those of change as such if any real understanding of the elements of the situation is to be attained. It is evident that a society might be ever so dynamic, as Professor Clark defines the term, and yet have all its prices "natural" or constantly equal to production costs, excluding any chance for the entrepreneur to secure a net profit. It is fallacious to define "natural" conditions as "static" conditions.


No a priori argument is necessary to prove that with general foreknowledge of progressive changes no losses and no chance to make profits will arise out of them. This is the first principle of speculation, and is particularly familiar in the capitalization of the anticipated increase in the value of land. The effect of any change which can be foreseen will be adequately discounted in advance, any "costs" connected with it will be affected in exactly the same way as the corresponding "values" and no separation between the two will take place.


It will be interesting to follow this line of thought somewhat farther, as suggested above in connection with Professor Clark's characterization of profit as the lure that causes men to make the efforts and take the risks involved in progress. It is in fact but a short step from the foreknowledge of change to the fact that change in reality does not usually just happen, but is largely itself the result of human activity. It is evident that if the laws of economically significant changes are known, those human actions which give rise to such changes will be governed by the same motives as the operations productive of immediate utilities, and in the competition of resources for profitable employment returns will be adjusted to equality between the two fields of use. Industrial progress would certainly take place under these conditions quite as readily as where the operations giving rise to it gave highly unpredictable results, but the rewards of making inventions, discovering new natural resources, etc., with the speculative character of the operations once removed, would be in no wise different from wages, interest, and rent in any other line of productive activity. They would be equal in amount, determined in the same way, in the same competitive market, and in short would be wages, interest, and rent merely, and not profit. And this is what does come about to the extent that progress can be foreseen, which is to say in very large measure. Dynamic changes give rise to a peculiar form of income only in so far as the changes and their consequences are unpredictable in character.


It cannot, then, be change, which is the cause of profit, since if the law of the change is known, as in fact is largely the case, no profits can arise. The connection between change and profit is uncertain and always indirect. Change may cause a situation out of which profit will be made, if it brings about ignorance of the future. Without change of some sort there would, it is true, be no profits, for if everything moved along in an absolutely uniform way, the future would be completely foreknown in the present and competition would certainly adjust things to the ideal state where all prices would equal costs. It is this fact that change is a necessary condition of our being ignorant of the future (though ignorance need not follow from the fact of change and only to a limited extent does so) that has given rise to the error that change is the cause of profit.


Not only may change take place without occasioning profit, but profit may also arise in the entire absence of any "dynamic" or progressive changes of the kind enumerated by Professor Clark. If conditions are subject to unpredictable fluctuations,*44 ignorance of the future will result in the same way and inaccuracies in the competitive adjustment and profits will be the inevitable consequence. And the failure of an anticipated change to occur is the same in effect as the occurrence of an unanticipated one. It is not dynamic change, nor any change, as such, which causes profit, but the divergence of actual conditions from those which have been expected and on the basis of which business arrangements have been made. For a satisfactory explanation of profit we seem to be thrown back from the "dynamic" theory to the Uncertainty of the Future, a condition of affairs loosely designated by the term "risk" in ordinary language and in business parlance.


Except for one or two passing references, Professor Clark does not take up the subject of risk in the treatise from which we have quoted. In a short article on "Insurance and Profits"*45 (written in refutation of Mr. Hawley) he takes the position that risk-taking gives rise to a special category of income, but that it accrues to the capitalist, and cannot go to the entrepreneur, as such. How he would treat this income, what relation it would bear to interest, he does not tell us. But it is no part of profit, which is defined as "the excess of the price of goods over their cost."*46 "It goes without saying that the hazard of business falls on the capitalist. The entrepreneur, as such, is empty-handed. No man can carry risk who has nothing to lose."*47 In his later work, the "Essentials of Economic Theory," the subject of risk again receives scant attention.*48 Risks are simply ruled out of the discussion, since "the greater part of them arise from dynamic causes," and the "unavoidable remainder" of static risk can be taken care of by setting aside "a small percentage of the annual gains [of each establishment, which]... will make good these losses as they occur and leave the businesses in a condition in which they can yield as a steady return to owners of stock, to lenders of... capital, and to laborers all of their real product."


It is clear that Professor Clark admits that his perfectly competitive state implies substantially perfect knowledge on the part of all members of society of present and future facts significant for the ordering of their business conduct. Dr. A. H. Willett*49 has supplemented the theory of the static state in this field, and Dr. A. S. Johnson has some discussion of it in his study of rent.*50 Willett recognizes that the disturbing effects of progress do not constitute the sole cause of divergence between actual society and the theoretical ideal; "the conception of the static state is reached by a process of abstraction," which "cannot stop" with the elimination of the five dynamic changes:

If all dynamic changes were to cease, the ideal static state would never be realized in human society. There are other assumptions which have to be made, such as a high degree of mobility of capital and labor, the universal prevalence of the economic motive, and the power of accurately foreseeing the future....
It is the influence of the last of these disturbing factors on static rates of wages and interest that we are to seek to determine. The ideal adjustment could be realized only on the condition that there were no discrepancies between the anticipated and the actual results of economic activity. Production and consumption must go on either with absolute uniformity or with a regular periodicity.*51


From the above admission that the static state is not an adequate formulation of the conditions of ideal competition, it would be an easy inference in line with static theory as a whole that some modification in the treatment of profit would be called for. But this inference is not drawn by the author quoted. He is not looking for and does not find any connection between profit and risk. He agrees explicitly with Clark that the entrepreneur takes risk only as a capitalist, and that the income resulting is therefore not profit. In his discussion of the reward for risk-taking, Willett states even more emphatically than Clark had done the contention that only the capitalist as such can take risk or get the reward of risk-assumption. To him this "seems to be a self-evident proposition,"*52 but he fails to take account of the familiar fact that men may secure their obligations in other ways than through pledging material resources already owned and invested, as for example by mortgaging their current income from all sources and their future earning power.


In his discussion of profits referred to above, Dr. Johnson makes some reference to risk, but he also makes no attempt to find in it an explanation of profit. He discovers four elements in "the income of a fortunate and capable entrepreneur."

(1) A gain due to chance, offset by a smaller loss (borne, however, by some other entrepreneur); (2) a gain due to his own power of combining labor and capital in ways more effective than those usually employed in the community; (3) a certain share in the first fruits of economic improvements; (4) a part of the gains which entrepreneurs as a class secure through the fact that their services are limited in proportion to the demand for them.


We need not stop to criticize this analysis in detail; it might be pointed out that shares (2) and (4) are identical, and that neither formulation would distinguish profit from wages (and (4) not from any other income, as we have remarked above); (3) is a reference to the "dynamic" explanation of profit and is unclear without further elaboration; (1) seems to point to a connection between profit and risk, but this is not worked out. It is clear that these discussions of risk, as emendations of the dynamic theory, make no pretense of explaining the connection between profit and uncertainty which our discussion of Professor Clark's treatment showed to be necessary. Both writers are, indeed, opposed to and attempt to refute the doctrine that profit is the result of assuming risk.


The doctrine that profit is to be explained exclusively in terms of risk has been vigorously upheld by Mr. F. B. Hawley,*53 who finds in risk-taking the essential function of the entrepreneur and therefore the basis of his peculiar income. In Mr. Hawley's distributive theory the entrepreneur, or "enterpriser" as he is called, plays a rôle of unique importance. Enterprise is the only really productive factor, strictly speaking, land, labor, and capital being relegated to the position of "means" of production. In regard to profit, the reward of enterprise, Hawley says:*54

...the profit of an undertaking, or the residue of the product after the claims of land, capital, and labor (furnished by others or by the undertaker himself) are satisfied, is not the reward of management or coördination, but of the risks and responsibilities that the undertaker... subjects himself to. And as no one, as a matter of business, subjects himself to risk for what he believes the actuarial value of the risk amounts to—in the calculation of which he is on the average correct—a net income accrues to Enterprise, as a whole, equal to the difference between the gains derived from undertakings and the actual losses incurred in them. This net income, being manifestly an unpredetermined residue, must be a profit, and as there cannot be two unpredetermined residues in the same undertaking, profit is identified with the reward for the assumption of responsibility, especially, though not exclusively, that involved in ownership.*55


Mr. Hawley is in agreement with Professor Clark and his followers in defining profit as "residual income," and as to the nature and basis of the special income connected with the assumption of risk as an excess of payment above the actuarial value of the risk, demanded because exposure to risk is "irksome"; but Hawley insists that residual income and uncertain income are interchangeable concepts,*56 while Clark is equally sure that the reward of risk-taking necessarily goes to the capitalist as such and that the pure profit of the entrepreneur is a species of monopoly gain arising in connection with dynamic disturbances, and that his only income under static conditions would be wages of management or coördination. Hawley contends that such income is wages merely, and not profit, and does not distinguish between "static" and "dynamic" conditions. Coördination, however, is in his view distinguished from labor by the fact of proprietorship, "which is the very essence of the matter in dispute."*57 Profit cannot be the reward of management, for this can be performed by hired labor if the manager takes no risk, but this individual is no longer an entrepreneur.


It is admitted that the entrepreneur may get rid of risk in some cases for a fixed cost, by means of insurance. But by the act of insurance the business man abdicates so much of his entrepreneurship, "for it is manifest that an entrepreneur who should eliminate all his risks by means of insurance would have left no income at all which was not resolvable into wages of management and monopoly gains" (i.e., no profit).*58 To the extent to which the business man insures, he restricts the exercise of his peculiar function, but the risk is merely transferred to the insurer, who by accepting it becomes himself an enterpriser and the recipient of an unpredetermined residue or profit." The reward of an insurer is not the premium he receives, but the difference between that premium and the loss he eventually suffers."*59


The clue to the disagreement and to the straightening-out of the facts as well is to be found in a confusion fallen into by those on both sides of the controversy, in assuming that the "actuarial value" of the risks taken is known to the entrepreneur. There is a fundamental distinction between the reward for taking a known risk and that for assuming a risk whose value itself is not known. It is so fundamental, indeed, that, as we shall see, a known risk will not lead to any reward or special payment at all. Though Willett distinguishes between "uncertainty" and "risk" and the mathematical probability of loss,*60 he still treats uncertainty throughout his study as a known quantity.*61 The same applies to Johnson; he also implicitly recognizes at various points that the true chance or actuarial value of the risk may not be known, and devotes some space*62 to Thünen's emphasis on the distinction between insurable and uninsurable risks; but he also fails entirely to take account in his discussion of profit of the fact that the risk involved in entrepreneurship is not and cannot be a known quantity.


In a similar way Hawley repeatedly refers to the fact of uninsurable risk as well as to "pure luck" and to "changes that no one could have foreseen," but he fails to inquire into its meaning or to recognize its theoretical import.*63 Once he goes so far as to say that "the great source of monopoly profit is to be found in the fact that the actuarial risk of any given undertaking is not the same for different entrepreneurs, owing to differences among them in ability and environment";*64 and again, that "profit is the result of risks wisely selected."*65 Even here, however, he fails to develop the point and draw the consequences from the fact that the actuarial value of the risk undergone by any venturer is not known, either to himself or to his competitors.


In a sense Mr. Hawley comes still nearer to the crux of the matter in his insistence on the responsibility and risk of proprietorship as the essential attributes of entrepreneurship. The entrepreneur is the owner of all real wealth, and ownership involves risk; the coördinator "makes decisions," but it is the entrepreneur who "accepts the consequences of decisions."*66 He admits that others than the recognized entrepreneur are subject to risk; the landlord is also a proprietor, and his land may change in value; the capitalist especially requires payment for the large risks he runs, and a part of both rent and interest is accordingly profit. A person who invests his own capital in any form of opportunity necessarily combines the two functions of capitalist and enterpriser. The same should apparently apply to the laborer, who is also admitted to run risks.


Mr. Hawley does not regard the term "risk" as calling for special definition, but it is clear that, like the other writers, he treats it as a known quantity; he says this much explicitly.*67 He and his opponents alike have failed to appreciate the fundamental difference between a determinate uncertainty or risk and an indeterminate, unmeasurable one. The only practical bearing of the question as to whether the value of the risk is known which is recognized by Hawley is to determine whether it is likely to be insured, which is to say merely who will get the "profit" for assuming it; even this point is not very explicitly made. Now a little consideration will show that there can be no considerable "irksomeness" attached to exposure to an insurable risk, for if there is it will be insured; hence there can be no peculiar income arising out of this alleged indisposition. If risk were exclusively of the nature of a known chance or mathematical probability, there could be no reward of risk-taking; the fact of risk could exert no considerable influence on the distribution of income in any way. For if the actuarial chance of gain or loss in any transaction is ascertainable, either by calculation a priori or by the application of statistical methods to past experience, the burden of bearing the risk can be avoided by the payment of a small fixed cost limited to the administrative expense of providing insurance.


The fact is that while a single situation involving a known risk may be regarded as "uncertain," this uncertainty is easily converted into effective certainty; for in a considerable number of such cases the results become predictable in accordance with the laws of chance, and the error in such prediction approaches zero as the number of cases is increased. Hence it is simply a matter of an elementary development of business organization to combine a sufficient number of cases to reduce the uncertainty to any desired limits. This is, of course, what is accomplished by the institution of insurance.


It is true that the person subject to such a risk may voluntarily choose not to insure, but it is hard to distinguish such a course from deliberate gambling, and economists have not felt constrained to recognize gambling gains in general as a special income category in the theory of distribution. If it is objected that practical difficulties may prevent insurance even where the risk is determinate, the reply is that insurance, in the technical sense, is only one method of applying the same principle. We shall show at length in our general discussion of risk and uncertainty that if the risk is measurable, but the "moral factor" or some other consideration makes ordinary insurance inapplicable, some other method of securing the same result will be developed and employed. When the technique of business organization has reached a fairly high stage of development a known degree of uncertainty is practically no uncertainty at all, for such risks will be borne in groups large enough to reduce the uncertainty to substantially negligible proportions.


The result of the foregoing analysis should be to show the inadequacy of the two opposed theories of profit and to indicate the reasons for it and the direction in which a tenable solution of the problem of profit is to be sought. It has been seen, first, that change as such cannot upset the competitive adjustment if the law of the change is known; and now, secondly, that an unpredictable change will be similarly ineffective if the chance of its occurrence can be measured in any way. In a well-organized society, if business men know either (1) what actual changes are impending or (2) the "risks" they run—i.e., what is the probability of any particular occurrence,—the effect in the long run is the same; the only result of such changes will be a certain redistribution of productive energy which will take place continuously and without any disturbance of perfect competitive conditions.*68 The fact that prediction may involve costs, and likewise the organization for grouping risks and eliminating their uncertainty, does not negate the truth of the proposition, so long as these costs are given elements in the competitive situation.


Yet it is equally evident that there is a principle of truth in both the "dynamic" and the "risk" theories, and the true theory must to a considerable degree reconcile the two views. On the one hand, profit is in fact bound up in economic change (but because change is the condition of uncertainty), and on the other, it is clearly the result of risk, or what good usage calls such, but only of a unique kind of risk, which is not susceptible of measurement. The Clark school has confused change with a common but not universal or necessary implication of change, and both schools have followed everyday speech into the fallacy of treating risk as a substantially homogeneous category, where a fundamental difference in kinds of risk is in fact the key to the whole mystery.


The meaning of "uncertainty," and of the different kinds of uncertainties, and their significance in competitive economic relations, will therefore constitute the principal subject which we have finally to investigate in the present study. The next step in the progress of the argument will be to lay a comparative basis for this investigation by attempting to gain a clear view of the mechanism of competitive valuation and distribution as they would be if uncertainty and its correlative profit were entirely absent. The next three chapters will therefore be taken up with an examination of the conditions and workings of a perfectly competitive society; of these conditions the crucial one will constantly appear as the possession of accurate and certain knowledge of the whole economic situation by all the competitors.

Notes for this chapter

Excellent histories of profit theory are to be found in the introductory sections of several monographs on profit and make it superfluous to go into this phase of the subject in detail. See especially the following:
    Mangoldt, H. v., Die Lehre vom Unternehmergewinn. Leipsic, 1855.
    Pierstorff, J., Die Lehre vom Unternehmergewinn. Berlin, 1875.
    Mataja, V., Der Unternehmergewinn. Vienna, 1884.
    Gross, G., Die Lehre vom Unternehmergewinn. Leipsic, 1884.
    Porte, M., Entrepreneurs et profits industriels. Paris, 1901.
The exception is Professor Clark's theory of perfect competition as equivalent to the "static state" and the corresponding "dynamic theory" of profit as the result of progress. This view will presently be taken up and criticized.
For a fuller discussion of the views of the English writers, with citations, see Cannan, Theories of Production and Distribution, chap. VI, sec. 2; also the same author's article on "Profit" in Palgrave's Dictionary of Political Economy. In opposition to the German historians and critics, who take the classical economists very literally, Cannan is sure that they really held, like their French followers, a wage theory of profit. Between the two views this seems the fairer on the whole, but it could hardly be maintained that the difference in expression does not represent some difference in thought. However, much of the contrast is undoubtedly due to differences in the use of terms. Old words used to designate new things necessarily become ambiguous, and "profit" is still correctly used with several different meanings.
Op. cit., p. 19, note.
Article, "Profit," in Coquelin and Guillaumin's Dictionnaire de l'économie politique, Paris, 1852. It is true that in another work (Traité d'économie politique, 2d ed., 1867) Courcelle was not so explicit, and also that in the same article he says that profit depends on the intelligence of the entrepreneur and the favorable or unfavorable conditions under which he works. This hesitation may explain Kleinwächter's classifying him with the followers of Say and adherents of the wages theory. (See Das Einkommen and seine Verteilung, p. 278.) It seems more probable, however, that Courcelle glimpsed the fact (which Kleinwächter did not) that the assumption of a "risk" of error in one's own judgment, inherent in the making of a responsible decision, is a phenomenon of a different character from the assumption of "risk" in the insurance sense. We shall build largely upon this distinction later.
These national designations of the two schools hold closely. The only notable exceptions (aside from Courcelle) are on the one side, Rossi, a French (naturalized Italian) writer, who strongly espoused the capitalistic or English view, and on the other Samuel Read who, while agreeing with the current English treatment in terminology, broke with it in substance and agreed with Say and his followers. Read insisted on identifying "profit" with the return to capital, or interest, and treating the distinctive income of the entrepreneur as a wage. He also emphasized the "compensation for risk" element in his "profit" (really interest), but thought it due to no determinate causes and "outside the pale of science." This last phrase shows at least an insight into the unique character of this sort of risk, since the assertion would certainly not have been made of an insurance premium. See his Political Economy, Edinburgh, 1829, pp. 263 and 269, note.
Neue Grundlage der Staatswissenschaft, vol. I. Giessen, 1807.
National Ökonomie, 1839.
Appeared 1826. 3d ed., 1876. See 3d ed., vol. II, pp. 83 ff.
See also the article "Unternehmergewinn," by Pierstorff in Conrad's Handwörterbuch der Staatswissenschaften. Dr. Thorstein Veblen's conceptions of capital and profit show strong leanings toward the same views.
Referred to above, p. 22 n.
G. Schönberg, Handbuch der PolitischenÖkonomie, 2d ed. (Tübingen, 1885), pp. 670 ff.
Ibid., pp. 220 ff.

Other works in the same group with the above are:

    E. Aug. Schroeder, Dab Unternehmen and der Unternehmergewinn. Vienna, 1884. (The same date of publication as Gross and Mataja.)
    A. Wirminghaus, Das Unternehmergewinn and die Beteiligung der Arbeiter am Unternehmergewinn. Jena, 1886.
    E. Zuns, Swei Fragen des Unternehmer-Einkommens. Berlin, 1881.
    A. Körner, Unternehmen and Unternehmergewinn. Vienna, 1893.
A noteworthy innovation in the treatment of profit has been made by a recent French writer, M. B. Lavergne, in his Théorie des marchées économiques (Paris, 1910). In his view profit is the remuneration of the idée productrice, which is elevated to the position of an independent productive factor. His book outlines an ingenious and suggestive theory of distribution. See review by Professor A. A. Young, American Economic Review, vol. I, pp. 549 ff.
Political Economy, part IV, chap. IV. See also "The Source of Business Profits and Reply to Mr. Macvane," Quarterly Journal of Economics, vol. I, pp. 265 ff., and vol. II, pp. 263 ff. (Macvane held a monopoly theory; cf. Quarterly Journal of Economics, vol. II, pp. 1 ff. and 453 ff.) A view similar to that of Walker has been advocated in France by Leroy-Beaulieu (Sr.). See Mémories de l'Academie des sciences morales et politiques, vol. I, pp. 717 ff, and Traité d'économie politique, part IV, chap. IX.
"Distribution as Determined by a Law of Rent," Quarterly Journal of Economics, vol. V, pp. 289 ff.
"The Law of the Three Rents," ibid., vol. V, pp. 263 ff.

More exhaustive than either Clark or Hobson is Wicksteed, The Coördination of the Laws of Distribution, London, 1894.

It is not meant that these are the only noteworthy advocates of the views in question, nor that other American writers on distribution have not been in some degree original in their treatment of profit. The discussions by the various authors—Davenport, Ely, Fetter, Fisher, Johnson, Seager, Seligman, Taussig, and others—are accessible everywhere. Perhaps especial mention should be made of the chapter on profit in Carver's Distribution of Wealth. Carver's distinction between compensation for risk-taking and the results of successful risk-taking points to the direction in which a solution of the problem is to be sought. Other writers also have seen the importance of a critical dissection of the risk concept, but none have so far carried out the work. Unquestionably the best of these textbook discussions is that of Professor F. M. Taylor in his unpublished Principles of Economics, a work characterized throughout by correctly reasoned and accurately stated theoretical argument.
See The Distribution of Wealth, 1900; and Essentials of Economic Theory, 1907.
The Distribution of Wealth, pp. 30, 31.
The Distribution of Wealth, p. 29.
Ibid., p. 66.
Ibid., pp. 68-69.
Ibid. Professor Joseph Schumpeter, who has carried the static analysis farther in some respects than Professor Clark, points out that in the static state there is no entrepreneur, properly speaking. The consumer, he adds, is really the entrepreneur; but it would seem preferable to say that the function is absent and let it go at that. (Theorie der Wirtschaftliche Entwickelung.)
The Distribution of Wealth, p. 404.
Ibid., p. 405.
Ibid., p. 406.
Ibid., p. 410. This is fallacious even under the assumptions, since the profits of change come largely in the form of readjustments of capital values. The difficulty is, of course, avoided if "friction" be so broadly defined that "perfect mobility" means the absence of all resistance to the human will. But in a world where a breath could transform a brick factory building into a railway yard or an ocean greyhound there would be no need for economic activity or economic science.
The Distribution of Wealth, p. 411. At this point Professor Clark makes a statement which if followed out would lead to serious questionings in regard to his analysis: "Profit," he says (p. 411), "is the lure that insures improvement, and improvement is the source of permanent additions to wages. To secure progress, this lure must be sufficient to make men overcome obstructions and take risks." (My italics.) It would seem that effort and risk have some connection with the income of the "entrepreneur as such," as well as change and friction. Along the same line is the statement in his first chapter (p. 3) that "free competition tends to give to labor what labor creates, to capitalists what capital creates, and to entrepreneurs what the coördinating function creates." When we ask, as we presently shall, whether the "effort" and "risk" connected with making progress, or the income to which they give rise, are essentially different from any other effort and risk and their incomes, we shall find ourselves forced to answer in the negative, and to look outside the fact of change altogether for an explanation of the unique income of the entrepreneur.
It may be objected that in regard to some changes it is an absurdity to imagine their being foreseen, since this would cause them to take place at once. The statement doubtless holds in regard to some discoveries of fact which to anticipate would be to make them now. But not many of the dynamic economic changes are of this sort. The accumulation of capital and increase in population are in fact relatively predictable and the broader features in the development of wants are known and the knowledge has no effect on the changes themselves. It is possible even to predict discovery of natural resources without saying just where they will be found, and the making of an invention without actually writing the specifications. The probability that inventions will be made and processes improved is in fact very frequently taken into account in making valuations and determining business policies. The assumption that all change might be predictable is contrary to fact, but not self-contradictory, and we leave it to the argument as a whole to justify its usefulness as well as legitimacy.
It is necessary to stipulate that the fluctuations must be of sufficient extent and irregularity that they do not cancel out and reduce to uniformity or regular periodicity in a time-interval short in comparison with the length of human life.
Quarterly Journal of Economics, vol. VII, pp. 40-54.
Ibid., p. 41.
Ibid., p. 46.
Footnote, pp. 122-23.
The Economic Theory of Risk and Insurance, Columbia University Studies in Political Science, vol. XIV, no. 2.
Rent in Modern Economic Theory. Publications of the American Economic Association, 3d Series, vol. III, no. 4. See chapter VI: "Rent. Profit, and Monopoly Return." (Both these monographs are doctoral dissertations written under Professor Clark's supervision.)
Willett, op. cit., pp. 13-14. (My italics.)
Ibid., p. 72.
The most complete exposition of Hawley's theory is in his book. Enterprise and the Productive Process (1907). Articles of earlier date in the Quarterly Journal of Economics contain briefer statements.
An earlier attempt by Mr. Hawley to present the essentials of his theory in the most compact form is superior in some respects and is worth quoting:

"The final consumer is forced to include in the price he pays for any product not only enough to cover all the items of cost to the entrepreneur,—among which items is a sum sufficient to cover the actuarial or average losses incidental to the various risks of all kinds necessarily assumed by the entrepreneur and his insurers,—but a further sum, without which, as an inducement, the entrepreneur, or enterpriser, and his insurers will not undergo or suffer the irksomeness of being exposed to risk.

"This surplus of consumer's cost over entrepreneur's cost, universally regarded as profit, and, from the nature of the case, an unpredetermined residue, is the inducement for the assumption by the entrepreneur, or enterpriser, of all the risks, whatever their nature, necessitated by the process of production. As the inducement to any given action and the reward for that action are the same thing,—the difference being not in the thing itself, but only in the point of time from which it is looked upon,—the unpredetermined residue, which served as the inducement to risk at the commencement of any industrial transaction must necessarily, when determined and realized at its close, be regarded as the result, reward, of the risks undergone." (Quarterly Journal of Economics, vol. XV, pp. 603-20.) (In the original the portion quoted is all in italics.)

Op. cit., pp. 106-07.
Quarterly Journal of Economics, vol. VII, p. 465; vol. XV, p. 88.
"Enterprise and Profit," Quarterly Journal of Economics, vol. XV, p. 86.
Quarterly Journal of Economics, vol. VII, p. 464. It should be explained that "monopoly gain" for Mr. Hawley includes all income due to limitation, and he finds that it forms a considerable portion of wages and interest, all of rent, and a large part of profit. We have repeatedly observed examples of this fallacy and remarked that there is no income which is not due to the "scarcity" of the agent securing it.
Enterprise and the Productive Process, p. 111.
Op. cit., pp. 27 ff.
Risk is defined as "the objective correlative of the subjective uncertainty" (p. 29), which varies with the mathematical chance of loss in such a way as to be at a maximum when the chances for and against the event are exactly even. But it is still to be regarded as a known quantity, since the mathematical chance is assumed to be known. Willett nowhere makes an explicit statement on this point, as Hawley does (see quotation in text on p. 42 above), but his discussion clearly shows that it is viewed as a known quantity. He takes his illustrations from games of chance or from the field of insurance, speaks of the influence of "a given degree of risk" (p. 65) on investors, etc. He does recognize the fact that the degree of risk is not always known in fact, and discusses methods of estimating the degree of risk; but (pp. 66 and 76) he expressly eliminates from the discussion the consequences of error in estimating the true value of the risk.
Op. cit., p. 112.
The reader will recall that many of the early discussions of profit (discussed in the early pages of this chapter), notably those of v. Mangoldt and v. Thünen, recognized the fact that some risks are insurable and others are not. No explanation of the fact, however, has been given, beyond phrases such as "in the nature of the case," which imply that it does not call for explanation.
"The Risk Theory of Profit," Quarterly Journal of Economics, vol. VII, p. 468.
Enterprise and the Productive Process, p. 108. Cf. Carver, "Risk Theory of Profits," Quarterly Journal of Economics, vol. XV, pp. 456 ff., and The Distribution of Wealth, chap. VII. Also A. A. Young in Ely's Outlines of Economics, 3d ed., chap. XXV. The phrase "successful risk-taking," used by both Carver and Young, like Hawley's "risks wisely selected," is certainly descriptive of the origin of profits. What is wanted is an examination of the meaning of risk-taking which will elucidate the conditions under which it will be successful and show the significant differences between cases of success and cases of failure.
"Enterprise and Profit," Quarterly Journal of Economics, vol. XV, p. 88.
See above, p. 42.
It must be understood that by laws and chances being "known," we mean that they are generally known, known to all to whom they are of any concern.

End of Part I Notes.

Part II, Chapter III.

End of Notes

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