Digressions 12 & 13

Question 1

Digression Opportunity costs and Maximization:
Which idea is closely related to Maximization?

Answer 1

The idea that rational decisions are based on the correct identification, evaluation and comparison of opportunity costs is closely related to the idea of maximization.

Question 2

Digression Opportunity costs and Maximization:
When is an individual a maximizer?

Answer 2

An individual is a maximizer if they consistently choose the best according to their subjective standard alternative among the available alternatives.

Question 3

Digression Opportunity costs and Maximization: What is meant with “satisficing”?

Answer 3

One is seldom in a position to know and precisely evaluate all the alternatives because of uncertainties regarding the relevant probabilities and cognitive limitations. Hence, a lot of people are not aiming for the best, but for a good enough alternative (satisficing)

Question 4

Digression Opportunity costs and Maximization:
Does satisficing contradict the idea of maximization?

Answer 4

At first glance satisficing seems to contradict the idea of maximization and thereby the concept that one should start by identifying and evaluating all opportunity costs.

However, advocates of the maximization approach have argued that the opposite is the case: satisficing is optimization wher all opportunity costs including the costs of processing information and optimization are considered.

It is disputed however whether this is a legitimate defense of the idea of maximization.
It brings the whole concept close to a tautology because it comes with the risk of explaining every type of behavior by identifying arbitrary and non-falsifiable opportunity costs.

Question 5

Digression Opportunity costs and Maximization:
What determines if you as a person are rather a “maximizer” or “satisficer”?

Answer 5

Strong genetic component

What studies with monozygotic and dizygotic twins have shown is that the tendency to satisfice or to maximize has a strong genetic component and that people can be categorized into “maximizers” and “satisficers”.

Question 6

Digression Opportunity costs and Maximization:
Who are the happier people, maximizers or satisficers?

Answer 6

Interestingly, maximizers tend to make better decisions than satisficers but are less happy with them.
One explanation for this apparent paradox is that even maximizers tend to fail to identify the best alternative in complex environments but are more aware of the fact that they may have failed to achieve their goals.

Hence, they often feel regretful when they evaluate their choices.
Therefore, in the end, the satisficer goes to the first ok-looking restaurant with the first ok-looking friend and spends a happy evening, whereas the maximizer continuously questions whether sushi with one would would have been better than pizza with Paul.

Question 7

Digression Firms as Production Functions and Firms as Organizations: How efficient can one possibly be?:
Which assumption are we examining?

Answer 7

The assumption that a point along the production function can actually be reached.

Question 8

Digression Firms as Production Functions and Firms as Organizations: How efficient can one possibly be?:
What underlies the assumption?

Answer 8

Underlying this assumption is the view that firms are able to organize economic activities within the firm in a perfectly efficient way.

Question 9

Digression Firms as Production Functions and Firms as Organizations: How efficient can one possibly be?:
Which simplification is used in the analysis of the interaction of supply and demand on markets?

Answer 9

The simplification of firms as a “black box” that entered their analysis as a production function.

Historically economists were not particularly interested in the management structures of firms and treated the firm as a black box that entered their analysis as a production function.

==> This simplification might be useful, if the primary focus of the analysis is the interaction of supply and demand on markets.

Question 10

Digression Firms as Production Functions and Firms as Organizations: How efficient can one possibly be?:
Why was this view of firm-as-production function challenged?

Answer 10

The firm-as-production function view was challenged when economists started to realize that they cannot explain the existence of firms as subsets of transactions that replace decentralized market transacactions with more centralized forms of governance.

Question 11

Digression Firms as Production Functions and Firms as Organizations:
What are the Principal-agent-theory, the contract theory or merely theory of the firm about?

Answer 11

a lot of literature on the internal organisation of firms and the boundaries between firms and markets has emerged that allows one to better understand under what conditions and with what kind of organizational structure companies can get to or close to the production function.
==> This issue boils down to understanding if firms can organize economic activities in a way that all interdependencies, which are internal to the firm are internalized (i.e. no firm-internal externalities exist).

The strands of the literature that focus on these problems are called
Principal-agent theory, contract theory
or merely theory of the firm.

Question 12

Digression Firms as Production Functions and Firms as Organizations:
What is the important point this digression is trying to make?

Answer 12

The important point is that one has to conceptually distinguish between the production function and the relationship between inputs and outputs, which exists given the (possibly imperfect) way economic activities are organized within a firm.

Question 13

Digression the limits of Profit Maximizatino: Information, Contracts and the Organization of firms:
What are the discussed reasons that firms do not maximize their profits?

Answer 13

1 imperfect information about costs and revenues.

2. the fact that firms are usually complex networks of networks of individuals with their own objectives (align the interest of the owners with the interests of the workers for example the CEO)

Question 14

Digression Evolution, Emotions and Sunk costs: When caring about sunk costs can be beneficial:
What is the example of the “ultimatum game” about?

Answer 14

Player 1 makes proposition to split money, player 2 can either accept or decline (then both get nothing).

With the sunk-cost principle player 2 should accept any positive amount but emotions such as anger and frustration or just feeling like the situation is unfair come to play, so that player 2 does not want player 1 to have a much bigger amount than them.

Question 15

What does the ultimatum game show us?

Answer 15

Digression Evolution, Emotions and Sunk costs:
This all shows that we should not classify the sunk-cost principle as the only rational way to make decisions; it all depends on the context.

Question 16

Digression The Ethics of Profit Maximization:
What problem do most people have with the concept of Profit Maximization?

Answer 16

Most people find it unethical, or even morally offensive, and claim that profit maximization is a major source of the problems of capitalist societies

Question 17

Digression The Ethics of Profit Maximization:
What is CSR?

Answer 17

The idea of corporate social responsibility (CSR) is seen as an alternative to profit maximization, which helps firms to better align their behavior with society’s interest.

Question 18

Digression The Ethics of Profit Maximization:
What is the definition of CSR by the 2001 greenbok by the European Union?

Answer 18

a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis.

Question 19

Digression The Ethics of Profit Maximization:
What was added to the definition of CSR 2001 in 2011?

Answer 19

” the responsibility of enterprises for their impacts on society”
==> this concept goes far beyond the narrow idea of profit maximization, which was put forward in 1970.

Question 20

Digression The Ethics of Profit Maximization:
What does this quote express?

Answer 20

Milton Friedmann said
“in a free economy there is one and only one social responsibility of business - to use it s resources and engage in activities designed to increase it s profits so long as it stays within the rules of the game”

Question 21

Digression The Ethics of Profit Maximization:
What are some examples for this approach that were mentioned in the econ book?

Answer 21

There are some examples for this approach in the preceeding chapters: externalities should be internalized by the design of property rights, contract law, taxes, regulations and so on, but not by appealing to firms to voluntarily internalize them by non-profit-maximizing business practices.

Question 22

Digression The Ethics of Profit Maximization:
Is it possible to bridge these opposing views?

Answer 22

For starters, one gets a lot of support for the so-called Friedman doctrine from the model of firm behavior under perfect competition, which was developed in this chapter.

First, note that the existence of a complete set of competitive markets implies an ideal institutional framework, which, in the language of Milton Friedman, could be understood as the perfect rules of the game.
==> this is expressed in the first theorem of welfare economics.

Second, with free entry and exit competition has the tendency to drive profits to zero.
However if profits are zero at the maximum, firms do not have much choice but to maximize them.
Paying higher wages to employees or selling at lower prices simply drives firms out of business.
==> The only exceptions to this rule are short-run profits, or a situation where entry and exit are restricted, such that profits are positive even in the long run.
However in this case, advocates of free markets would argue that one should first try to reduce the entry and exit barriers to the largest extent possible, in this case.

==> Under perfect competition there is not much room for anything but profit maximization.

Question 23

Digression The Ethics of Profit Maximization:
Why do you have to be careful when judging firms that voluntarily choose ethically sound business practices?

Answer 23

Their existence does not necessarily imply that firms incorporate other objectives than simply profits into their business models.

1 Paying decent wages = employees being more motivated to work harder

2 Sustainability standards may lead to higher prices if consumers have a willingness to pay for sustainable productio etc.

Question 24

Digression The Ethics of Profit Maximization:
What is responsible profit maximization?

Answer 24

a lot of proponents of CSR reduce the concept to this “enlightened self-interest” of the firm, the argument being that a lot of potential conflicts of interest between the owners and managers of firms (shareholders) and other groups in society (stakeholders) result from a too-narrow perspective of the shareholders. This view implicitly accepts the profit motive but aligns it with social interests by declaring them compatible. The approach could also be called responsible profit maximization.

Question 25

Digression The Ethics of Profit Maximization:
What does perfect competition depend on? What does this lead to?

Answer 25

one has seen that perfect competition depends on technological prerequisites, which are not always fulfilled and that externalities may make an equilibrium inefficient.
In situations like these, there is room for discussion about the adequate way to address inefficiencies and problems of sustainability as well as distributive justice on the firm level.
Example: one of the major challenges of globalization is exactly the lack of a consistent glaobal reuglatory framework - the rules of the game - that create a perfectly level paying field, and institutions like the WTO od OECD are too weak to fill the holes and gaps in the playground (Nevertheless CSR goes beyond the problems imposed by globalization).

Nation states even enter into race-to-the-bottom types of international competition where they reduce taxes and social standards to attract internationally mobile capital. This type of competition can, in principle, be beneficial, if it is primarily utilizied as a disciplinary device for nation states to provide public services more efficiently but it often drives standards below the efficient level.
Especially large multinational corporations can profit from these developments and for the foreseeable future there is no other institutional actor able to address the ethical issues that result from these developments other than the corporation themselves.
==> IF they do not care, no one will.