Risk, Uncertainty, and Profit
By Frank H. Knight
The text has been altered as little as possible from the original edition (
Risk, Uncertainty, and Profit, Frank H. Knight, Ph.D., Associate Professor of Economics in the State University of Iowa; Boston and New York, Houghton Mifflin Co., The Riverside Press, 1921).A few corrections of obvious typos were made for this website edition. However, because the original edition was so internally consistent and carefully proofread, we have erred on the side of caution, allowing some typos (such as for proper nouns and within references) to remain lest someone doing academic research wishes to follow up. We have changed small caps to full caps for ease of using search engines.Lauren Landsburg
Editor, Library of Economics and Liberty
First Pub. Date
Boston, MA: Hart, Schaffner & Marx; Houghton Mifflin Co.
1st edition. Based on award-winning dissertation essay.
The text of this edition is in the public domain. Picture of Frank H. Knight courtesy of Ethel V. Knight.
The Place of Profit and Uncertainty in Economic Theory
Part I, Chapter I
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.
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.
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.
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.
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
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.
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.
Introduction to Social Philosophy, p. 58. Also Bagehot,
Economic Studies, no. 1: “The Presuppositions of English Political Economy.”
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.
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.
Part I, Chapter II.
Die Lehre vom Unternehmergewinn. Leipsic, 1855.
Die Lehre vom Unternehmergewinn. Berlin, 1875.
Der Unternehmergewinn. Vienna, 1884.
Die Lehre vom Unternehmergewinn. Leipsic, 1884.
Entrepreneurs et profits industriels. Paris, 1901.
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.
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.
Political Economy, Edinburgh, 1829, pp. 263 and 269, note.
Handwörterbuch der Staatswissenschaften. Dr. Thorstein Veblen’s conceptions of capital and profit show strong leanings toward the same views.
Handbuch der PolitischenÖkonomie, 2d ed. (Tübingen, 1885), pp. 670 ff.
Other works in the same group with the above are:
Dab Unternehmen and der Unternehmergewinn. Vienna, 1884. (The same date of publication as Gross and Mataja.)
Das Unternehmergewinn and die Beteiligung der Arbeiter am Unternehmergewinn. Jena, 1886.
Swei Fragen des Unternehmer-Einkommens. Berlin, 1881.
Unternehmen and Unternehmergewinn. Vienna,
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.
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.
Quarterly Journal of Economics, vol. V, pp. 289 ff.
ibid., vol. V, pp. 263 ff.
More exhaustive than either Clark or Hobson is Wicksteed,
The Coördination of the Laws of Distribution, London, 1894.
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.
The Distribution of Wealth, 1900; and
Essentials of Economic Theory, 1907.
(Theorie der Wirtschaftliche Entwickelung.)
overcome obstructions and take risks.” (My italics.) It would seem that
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.
op. cit., pp. 13-14. (My italics.)
Enterprise and the Productive Process (1907). Articles of earlier date in the
Quarterly Journal of Economics contain briefer statements.
“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.)
Quarterly Journal of Economics, vol. XV, p. 86.
Quarterly Journal of Economics, vol. VII, p. 468.
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.
Quarterly Journal of Economics, vol. XV, p. 88.
generally known, known to all to whom they are of any concern.
End of Part I Notes.
Part II, Chapter III.