The Journey, Not The Destination: Kirzner and Alchian

“Ends can be conceived as observable states of affairs only after their achievement.” -Israel Kirzner

In his book The Economic Point of View, Israel Kirzner notes that as the study of Economics has developed, economists have tended to miss key parts of economic behavior. One of the errors Kirzner detects is a tendency to forget that purpose is the key to human action. We cannot take “ends” as a given, because every person has her own. Though a person may achieve something that was desired, how the desire was fulfilled is where the economic activity happens. The choices between different possible means to the end involve weighing tradeoffs, using scarce resources, and sacrificing some goals for the sake of others.

So, we can’t just ignore the choices that led to the ends. In the case of business, it would be silly to say that the goal of a business is “profit maximization.” Not because it is untrue, but because it misses a step. The most profitable businesses do survive, but business owners can’t be successful by waking up in the morning and thinking, “I will maximize profits today!” It would be the same as a student declaring that she will get all A’s in her classes, without any plan to make it happen.

The process of profit-maximization is one of constant innovation. Some of these innovations will be amazing, like iPhones, and others will flop, like Kodak’s switch to digital photography. Arman Alchian likens this process to evolution, where some developments are beneficial to an organism, and others are not. Companies that innovate in a way that consumers like are profitable, and companies whose innovations are not embraced will fail.

Successful companies do maximize profits, but that is because they are making good decisions. They cannot make good decisions by trying to maximize profits. This may seem like a tedious point, but it is essential to keep in mind that individual decisions are at the heart of economics. Innovation cannot be taken for granted, because it is always the result of someone’s hard work.

So companies, like people, are trying to make the best decisions given the goals they want to achieve. In economics, as in other parts of life, it is the journey and not the destination that really matters.

The quote at the top of the post is from The Economic Point of View6.36

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In Defense of Judging a Book by Its Cover

 

There are many common adages to which economists object, but the one that really bugs me is “Don’t judge a book by its cover.” And while I understand what the phrase tries to convey, disregarding the value of quick judgements misses an essential part of human decision-making.

If we aren’t allowed to judge a book by its cover, how do we decide which to read? Given that we don’t have time to read every single book in the library, we must decide which book we will like best based on the title and the paragraph on the back. Certainly, we will make poor decisions at times. The book that looks like it could be a New York Times Bestseller could be as interesting as watching a snail race. But on the whole, we would generally pick books that we enjoy reading. In the same way, buying laundry soap would be a hassle if we had to look up all relevant scientific information regarding the efficacy and safety of the brands carried by the store before we made a decision of which to buy. It is not worth our time. Small decisions with low-stakes are best made quickly because the benefits of extra knowledge are smaller than the value of the time expended to find that information.

However, I would argue that large decisions also benefit from these judgements. In the case of meeting a new person, it only takes a few minutes to decide if you two are likely to become close friends. These judgments might lead us to occasionally miss out on good (unexpected) friendships, but we live in a world of scarce resources and we do not have the time to get to know every person before deciding if it is worth investing additional resources in a friendship.  If a person is able and willing to invest more time in making a judgement, she is more likely to make a wise decision. But we are capable of making a tolerably good (if often sub-optimal) decisions with only small amounts of information.

Agree? Disagree? I’d love to hear your thoughts.