And now Ritchie declares that all microeconomics is wrong

I think the finger can be unambiguously pointed at micro-economists. Because this breed has over the last 60 or so years become obsessed with seeking to solve all problems mathematically they have to make massive simplifying assumptions about the true nature of human (and so corporate) behaviour to reduce life to terms that they can handle in their equations. One of those massive assumptions is that companies have a duty to maximise profits. If they did not make this assumption they could not otherwise mathematically model corporate behaviour in the abstract, as they do, rather than look at its reality, which they don’t.

But the fact that there is a fundamental flaw at the heart of conventional microeconomics because it is built on an assumption that is not only wrong,because as a matter of fact companies do not only not maximise profit but would have no clue what to do if instructed to do so, does not make that false assumption right. It should just instead lead us to doubt the advice of those who offer suggestion on the basis of such falsehoods.

And nor does an economist’s false assumption create law that does not exist.

Great, isn\’t it? Someone who prodly tells us that he never paid a whit of attention to his economics classes at univerwsity, that he\’s figured it all out for himself, now tells us that everyone else is just wrong. All those very clever people who have worked on this for well over a century: nope, ignorant nobodies. A Retired Accountant From Wandsworth has the one true and valid scheme!

BTW, economists do not claim that companies have a duty to maximise profits. They claim that companies attempt to maximise profits. Even, that the purpose of a company is to attempt to maximise profits.

19 thoughts on “And now Ritchie declares that all microeconomics is wrong”

  1. Directors of companies have a fiduciary duty to act in the interests of shareholders (subject to the over-riding constraints of the law and their Articles of Association). So economists approximate by assuming they will maximise profit (which is shorthand for saying that they maximise the value of the enterprise as the discounted free cash flow available to be distributed as dividends).
    Either Ritchie doesn’t understand the abbreviated phrase or he wants to change the law by abolishing fiduciary duty of directors, or both.

  2. Well, quite. He’s just peddling a very simplistic idea that amounts to a myth. One that seems to be very popular on the Left, though.

    “Prodly” is a word you should use more often, Tim.

  3. According to a close relative – he has a ‘deep and complex grasp of economics’ – I agree, at least his own version of it. The brilliant @MurphyRichards is, base on this kind of utterance, likely to become redundant as Murphy is fast becoming beyond satire. I agree with Ian B, though (#4) – this analysis is becoming more powerful amongst the Left by the day.

  4. Brian, follower of Deornoth

    “become obsessed with seeking to solve all problems mathematically they have to make massive simplifying assumptions”

    So that’s the Warm-mongerers told, then.

  5. Bill Poster, microeconomist

    Making a few of those important and useful (but apparently now ridiculous) simplifying assumptions, we should tell Ritchie that is doesn’t even matter if not all companies act to maximise profits. Suppose a profitable investment opportunity exists. Should we predict that it will be undertaken? If the opportunity is available to a SINGLE profit-maximising agent, then yes. What is a significant source of profitable investment opportunities? Existing firms that are not profit-maximising. Buy, improve, sell. Repeat. Show me a firm that is not maximising share value, and I’ll show you firm that’s about to be acquired.

  6. This is an odd objection from the left, because left wingers often complain about companies doing bad things because they are greedy swine only interested in profits, and short-term profits at that.

    What makes him think profit maximization is the only thing economists are capable putting into maths? Admittedly some nebulous concepts would be hard to formalise.

  7. “Because this breed has over the last 60 or so years become obsessed with seeking to solve all problems mathematically they have to make massive simplifying assumptions about the true nature of human (and so corporate) behaviour to reduce life to terms that they can handle in their equations….”

    Hmm. A trifle unfair to the behavioural variety of micro-economist, I think.

  8. This is from the Ritchie, who two years ago was praising the mathematical analysis of economics and the level of numerical modelling (specifically the likes of C+I+G=Y (macro – I know but still)) that economists could conduct.

    I wish he would stick to a single hymn sheet and stop adding in his own words.

  9. Last I saw it was plausibly suggested that firms tend to maximise revenue (consistant with satisfying profit demands).

    Plausible because very few CEO’s will turn down a chance to “grow” the company.

  10. all these generalisations about what firms do….some firms like to maximise employee involvement – Google anyone?…or the original version of Marks and Spencer….where Sieff realised that if they provided good canteens for the staff, they would feel loyalty and work harder. Life is just too complex for a WGCE like the Murph-meister.

  11. The legal obligation was always to advance the best interests of shareholders over the long term. Doesn’t necessarily mean short term profits at all – could mean growth and potential and share price.

    And anyway overtaken in the new company law rules in the UK requiring directors to take account of the best interests of employees, suppliers, the environment, etc., etc.

    So as far as duties go, lawyers not economists in the first place, and neither, currently.

  12. about the true nature of human (and so corporate) behaviour

    So for once he’s admitting that corporations don’t really have an independent existence and that there’s a collection of humans back there somewhere?

    When it’s behaviour, they’re humans, when it’s paying tax they’re companies. *Now* can we discuss tax incidence?

  13. john77 has it right. The duty is to the shareholders.

    If the shareholders use the company to pay school fees, to provide the board of close family members with their annual holiday or anything else that’s fine.

    If the company has an appointed director, the director must consult with the shareholders about what they want the company to do – it could be to “maximise NPV”.

    Richie is right though that the mathematics of microeconomics are pretty child-like. Usually simplistic linear equations based on simple observations and the graphs have their major axes plotted reverse in comparison with science. Error analysis is pretty flawed too. As ever though, his conclusions are plucked out of thin air and have nothing to do with his previous statements.

  14. Even better … we make the assumption that profit maximization is the goal … and then we let that assumption lead us to implications that can be tested with data.

    Funny thing that … those tests strongly suggest that we’re on the right track.

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