Maximization of Profit

Author(s): C. A. Ashley
Source: The Canadian Journal of Economics and Political Science / Revue canadienne
d'Economique et de Science politique, Vol. 27, No. 1 (Feb., 1961), pp. 91-97
Published by: Wiley on behalf of Canadian Economics Association
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 Notes and Memoranda 91
StandardClassificationSystems
The revised StandardIndustrialClassificationManualis now being printed.
In the meantime, much work has been done towards implementing it in the
various statistical surveys made for the purpose of obtaining information from
industry. When the classification was being revised, a good deal of attention
was paid to the question of developing a uniform definition of "establishment."
In most cases, the establishment is the unit from which information is obtained
and, therefore, a standard definition facilitates the obtaining of data from the
same respondents on different surveys such as the census of manufactures, and
employment statistics.
A further move toward the integration of industrial statistics from different
sources is the "Standard List of Establishments." This project consists of
matching the lists used on existing surveys and eliminating inconsistencies so
that the coverage of each survey can be described as a certain segment of the
standard list. The matching of manufacturing and mining establishments has
been completed and work is now proceeding on other industry divisions. In
manufacturing, it is planned that the new definition of establishment will be
applied to 1961 data. Thus, there will be a break in the series and steps are
being taken to ensure that a desirable degree of historical continuity is
preserved.
Two volumes of the StandardCommodityClassificationhave been published
and it is expected that the third volume, an alphabetical index, will be issued
during 1961. The details of materials used and shipments on the census of
industry schedules are being brought into line with the standard classification.
Since all schedules will undergo a major revision for 1961 data, those that are
not already on the standard basis will be made to conform at that time.
A programme for implementing the Standard Commodity Classification in
external trade statistics is well advanced. Exports will be put on the new
classification beginning January, 1961. Tests have been made and the new
classification has been printed. A first draft of the classification for imports is
now ready and is being examined by those most immediately concerned to
ensure that it is practicable and that it provides the best possible data. A
second draft will be ready in the spring. Barring unforeseen obstacles, the
new classification system will be used for imports beginning January, 1962.
The classification of occupations to be used for the 1961 census, and also to be
used widely for other statistical series, has been revised and is now being
indexed. The classification manual will be available before the middle of 1961.

MAXIMIZATIONOF PROFIT*

C. A. ASHLEY
University of Toronto

THE assumption that, in business transactions, men try to maximize profits has
recently been widely questioned after a long and almost undisputed run.
*A revised version of a paper presented at the annual meeting of the Canadian Political
Science Association in Kingston, June 11, 1960.
Vol. XXVII, no. 1, Feb., 1961

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 92 Canadian Journal of Economics and Political Science
Some people still believe that the wish to make the best bargain is innate, an
extension of an instinct of self-preservation. However, this preoccupation with
material benefits is by no means universal.' The times when maximization of
profit is most widespread are probably those when rapid change is taking place
in economic life, in an economy not far from subsistence level, when the
differences between classes of society are being accentuated. In fact, in western
Europe and North America around the turn of the eighteenth century, when
the assumption came to be fairly generally accepted, it was true enough to be
a reasonable generalization. The established system of welfare, however
inadequate it may have been by modern standards, was breaking down; the
harshness of the new industrial system was unmitigated in an atmosphere of
survival of the fittest; and an entirely new standard of living was available for
those who were successful. Bentham could write: "Each portion of wealth is
connected with a corresponding portion of happiness. Of two individuals,
possessed of unequal fortunes, he who possesses the greatest wealth will
possess the greatest happiness."2 But even during this period, so the novelists
persuade us, the business man was convinced in his own mind that he was
actuated by far wider motives than personal gain.3 Gradually the new rich
ceased to be always "on the make"; and the workers, saved from exploitation
by Factory Acts and the growth of trade unions, became reasonably content
with their lot. The maximization of profit was left, and has largely remained,
with the middle class: the small entrepreneur and the shopkeeper, and to some
extent the lower levels of professional men; those personally subject to the
greatest competition, with a fair chance of rising to a higher class or falling
to a lower one.
The rise in the standard of living, and state intervention in matters of
education, health, and social security generally, have brought western Europe
and North America again to a stable economy in the sense that maximization
of profit has lost its relevance to a vast proportion of business transactions,
save in places where poverty of resources and pressure of population have
slowed down the change. There, haggling about prices still persists except
among the rich. In the rest of the Western world, the satisfaction of the bargain
hunter is derived more from the chase itself than the kill. "Most human motives
tend on scrutiny to assimilate themselves to the game spirit."4The wish to get
the better of someone else may be a common enough motive, but it does not
necessarily result in maximization of profit, and may result in actual loss with-
out reducing appreciably the satisfaction derived from it.
Any period of rapid economic change resulting from innovation, which may
present the opportunity for large profits to be made quickly, is likely to bring
to light striking examples of profit maximization. On the other hand, in one
sector of the economy, that of public enterprise, which accounts for a large
and growing volume of business transactions, the maximization of profit is
manifestly of secondary importance, although lip service may be paid to it.
1W. A. Lewis, The Theory of Economic Growth (London, 1956), 38.
2Quoted in L. Robbins, The Theory of Economic Policy (London, 1952), 62.
3See C. A. Ashley, "The Business Man in Fiction," CommerceJournal, 1956, 71-81.
4F. H. Knight, Risk, Uncertainty and Profit (London, 1933), 53. See also W. J. Ryan,
Price Theory (London, 1958), 24; and K. Mannheim, Man and Society (London, 1940),
315.

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 Notes and Memoranda 93
A very large proportion of business is transacted by officials on behalf of
limited companies. We are justified in supposing that if they try to maximize
profits it is their own profits that they will have in mind rather than those of
the company, and there is no reason to expect the maximization of the one
to lead to that of the other. "How interesting it would be, having surveyed the
classical contribution to the solution of these problems, to proceed to examine
to what extent, according to our lights and our ethical postulates, these con-
tributions are in any sense valid. . . . In what measure has this theory been
rendered obsolete by the development of joint-stock companies and the limited
liability principle?"5 It must be admitted that many of the day-to-day transac-
tions of companies are not as likely to be affected as are long-term decisions,
but policy decisions account for a large volume of transactions. "But in recent
years, 'profit maximization' has been extensively qualified by theorists to refer
to the long run: to refer to management's rather than to owner's income; to
include non-financial income such as increased leisure . . . the concept has
become so general and hazy that it seems to encompass most of man's aims
in life."" The remuneration of management is totally different from the pay-
ment of wages, and is of some magnitude. "Maximization of salaries and
bonuses of professional managers may constitute a standard of conduct
different from that implied in the customary marginal analysis of the firm.
The extent to which the two standards would result in sharply different action
under otherwise similar conditions is another open question in need of
investigation."7
It is worth noting how ill understood are the operations of companies by
some economists. "The investors as a whole get the residual share of the
income arising out of the business, and from this point of view it is only
natural that they should control the managers. Management, therefore, will
run a business as profitably as it can, in the interest of the residual shareholders
-it will certainly have to justify any actual loss as unavoidable, in spite of
proper foresight and planning."8 All the massive work on the control of com-
panies written in the past twenty-five years is ignored in this quotation.
Management is seldom at a loss to find a reason for losses (tariff policy, high
wages, etc.), if it bothers to give a reason at all; it often seems to think little
of shareholders and although shareholders are sometimes organized to replace
directors, this seems as likely to happen in a successful company as in one
operating at a loss. Many other transactions of importance result from ex-
pansion of existing companies. Professor Keirstead says: "If a firm proposes
to use funds of its own, taken, say, from its reserve of undistributed profits,
it ought not, on the profit-maximizing principle, to use such funds for its own
expansion if it cannot anticipate a return in excess of this opportunity cost."9

5Robbins, The Theory of Economic Policy, 206. See also C. A. Ashley and J. E. Smyth,
CorporationFinance in Canada (Toronto, 1956).
6J. Dean, Managerial Economics (New York, 1956), 28. See also H. R. Bowen, Social
Responsibilities of the Businessman (New York, 1953), passim; and V. A. Demant, Religion
and the Decline of Capitalism (London, 1952), chap. VI.
7F. Machlup, "MarginalAnalysis and Empirical Research,"American Economic Review,
XXXVI, no. 4, Sept., 1946, 528.
8p. W. S. Andrews, ManufacturingBusiness (London, 1949), 4.
9B. S. Keirstead, Capital, Interest and Profits (New York, 1959), 58.

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 94 Canadian Journal of Economics and Political Science
The directors of companies as a whole are not inclined to pay out substantially
all of the profits of a year as dividends to shareholders, and many instances
can be found of companies undertaking expansion when the prospects make
it obvious that the rate of profit, in the short run, will be less than in other
lines of business. It is very doubtful if they have the prescience to say what
the long run has in store. These undistributed profits would, in the hands of
shareholders, have a better chance of being used to maximize profits.
The total of the transactions mentioned above may still leave a large propor-
tion of the transactions in number, if not in value, subject to the maximization
of profits, but Professor Boulding throws doubts on the whole of them. "This
is to say that the theory of profit maximization is only applicable to the case
in which all markets are perfect.... Also it is applicable only when there is
no uncertainty so that we never have to balance lucrativity against security.
. . . It only becomes an analysis of behaviour if we make the further assump-
tion that people act according to their best advantage. In the case of individuals
this assumption is only occasionally true."'0 An additional difficulty that arises
often enough is that a business man does not have the knowledge to enable
him to maximize profits, but some economists believe that, nevertheless, he
does in fact act to this end most of the time." Apart from what may be called
renegade economists, a wide assortment of sociologists and psychologists have
challenged the validity of the assumption of profit maximization with the proviso
ceteris non paribus at almost every point. Mrs. Robinson's treatment of these
objections is cavalier and a trifle complacent. "The study of human decisions
involves a study of human psychology, but the background of psychology
which economics requires is purely human behaviourist psychology. When
the technique of economic analysis is sufficiently advanced to analyse the
results of neuroses and confused thinking, it will study the effects."'12 "But
since the principle of maximizing money gains provides a convenient objective
criterion of common sense, it appears profitable to assume that all sellers are
sensible and all endeavour to maximize their money gains."13If neuroses are
common, if confused thinking is rampant, or if some people have different ideas
of what is sensible, the only thing to do is to ignore them, and get on with the
study of economics.
A number of economists have taken the dramatic point of view that firms
which do not try to maximize profits are not long for this world, and have used
this as an argument that most firms do try to maximize their profits. "If any
organization is to continue as a profitable enterprise, it must be as efficient as its
competitors."14How can one judge the efficiency of a business? If by the rate of
profit, then the rate must be the same for all competitors, or else any with a lower
rate must operate at a loss and disappear. "Those who do not behave in the most
advantageous way do not ultimately survive."'15Another author writes: "Because
they were, in this sense, theories of competition, they were also theories of
i?K. E. B3oulding,The Skills of an Economist (Cleveland, 1958), 59.
"1M.Friedman, Essays in Positive Economics (Chicago, 1953), 21.
12J.Robinson, Economics of Imperfect Competition (London, 1953), 16.
.3bid., 213.
14R. Brech, "Economicsin Business,"Advancement of Science, XV, no. 61, 482.
'5Boulding, The Skills of an Economist, 61.

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 Notes and Memoranda 95
probable survival. The more nearly a firm's actions might correspond to the
actions supposed, the larger were likely to be its profits, or the less its losses, and
the greater its chance of building up reserves, of securing capital with which to
expand and of surviving in the face of competition."'6 "Whenever this deter-
minant happens to lead to behaviour consistent with rational and informed
maximization of returns, the business will prosper and acquire resources with
which to expand; whenever it does not, the business will tend to lose resources
and can be kept in existence only by the addition of resources from outside."17
There are, of course, plenty of examples of companies which operate at a loss for
considerable periods, and of others which operate at consistently lower rates of
profit than their competitors, and automatic expansion by profitable companies
does not always increase their chance of survival.
The appeals made to empirical tests of the assumption of profit maximization
do not appear to be particularly conclusive. Professor Scitovsky states: "About
the firm, we shall make the much more tangible and definite assumption that
it aims at maximizing its profits. Profit, unlike satisfaction, is a measurable
quantity. It is expressed in terms of money; and its magnitude can be ascer-
tained from the firm's Profit and Loss account. Hence, by saying that the firm
aims at maximizing profit, we make a statement about the firm's behaviour
which can be proved true or false."'8 Professor Lange expresses a similar view:
"Money profit is a quantity which can be observed empirically (like, for
instance, velocity in physics). . . . Direct observation tells us, then, whether
firms do or do not maximize money profit."'19It is unusual for economists to
place such faith in the accountants' concept of profit. The profit of a firm
cannot be ascertained "accurately" from its profit and loss account. It is not
unknown for the management to vary the profits by manipulation of figures,
particularly in inventory valuation, to suit whatever purpose they have in
mind. We are not told what degree of accuracy is necessary nor the method
of proof used to draw the astonishing conclusions stated. One wonders
whether, if the writers of these statements knew what the market behaviour
of a firm had been, they could detect its managers in deliberately under-
stating inventory values. If a firm is profitable, how can one prove, not what
the motives have been-that would be going too far20-but that different actions
would have increased or decreased the profit?
Professor Ryan makes an equally unsatisfactory statement: "There is no
direct and unambiguous evidence to support this assumption: one main justifi-
cation for making it is that revisions of sales plans that it suggests concur with
our observations of what actually happens when firms revise their sales plans
in response to changes in the planning data, and that it is consistent with what

16E. A. C. Robinson, "The Pricing of Manufactured Products," Economic Journal, Dec.,

1950, 774.
17Friedman,Essays, 22.
18T. Scitovsky,Welfare and Competition (Chicago, 1951), 111.
1'9"TheScope and Method of Economics," Review of Economic Studies, XIII, 2.
20"The peculiar feature of the imputation of motives is that we are asserting a nexus
between an overt action and a purely subjective factor that cannot be exposed to any kind
of direct scrutiny and is not as such manifest in action." R. M. McIver, Social Causation
(Boston, 1942), 203.

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 96 Canadian Journal of Economics and Political Science
we know of the motives of businessmen.' Is there not a circular argument
here? What we know of the motives of business men is derived from our
observations of their behaviour, and their behaviour is gratifyingly consistent
with what we know of their motives. Professor Friedman states that the
evidence for the maximization of returns is to be found in countless applica-
tions of the hypothesis to specific problems. "This evidence is extremely hard
to document: it is scattered in numerous memorandums, articles, and mono-
graphs."22He might, perhaps, have chosen from these one striking example.
I make no pretence of a knowledge of all the literature, but I have been struck
by the number of times I have come across such claims substantiated, if at all,
only by examples couched in the most general terms. Later, Professor Friedman
also misses an opportunity. "Suppose the problem is to determine the effect on
retail prices of cigarettes of an increase in the federal cigarette tax. I venture
to predict that broadly correct results will be obtained by treating cigarette
firms as if they were producing an identical product and were in perfect
competition."23 He does not, however, venture to predict what would in fact
happen, so that we could determine empirically how broad "broadly" is. It is
a debating point that Veblen, despised by economic theorists, "predicted that
the price of wheat would remain below 91 cents for the next decade and with
the exception of 1898, when it was 93 cents, his prediction was fulfilled."24
We are not told what method he used, but the result was spectacular.
Some economists believe, unreasonably I think, that the onus of proof falls
on those who raise objections; others, that unless a better hypothesis can be
suggested, the old one is good enough. Mrs. Robinson, for instance, writes,
"Meanwhile I am inclined to retort to those who grouse about the assumption
that the entrepreneur's aim is to maximize profits in the immortal words of
Old Bill: 'If you know of a better 'ole, go to it.'"25 The figure of speech is apt,
for the cartoon of Old Bill (dating from over forty years ago) shows him in
a hole which appears to be the target of artillery fire from all directions.
Perhaps, if he had scampered away, he might have found a place where he
could have dug himself a better hole; his horizon was limited. But as Professor
Scitovsky says, "we have a vested interest in maintaining this assumption-it
makes economic analysis so much easier."26
Professor Macfie has written of "the narrow inadequacies of the economists'
assumptions";27and Schumpeter had this to say:
. . . the family and the family home used to be the mainspring of the typically
bourgeois kind of profit motive. Economists have not always given due weight to
this fact. When we look more closely at their idea of the self-interestof entrepreneurs
and capitalistswe cannot fail to discover that the results it was supposed to produce
are really not at all what one would expect from the rational self-interest of the
detached individual or the childless couple who no longer look at the world through
21Price Theory, 69.
22Essays,220.
23Ibid.,36.
24H. A. Innis, Essays in Economic History (Toronto, 1956), 21.
25"ImperfectCompetition Revisited," Economic Journal,Sept., 1953, 582.
26"A Note of Profit Maximization and Its Implications," Review of Economic Studies,
XI, no. 1, 57.
27"Choicein Psychology and Economic Assumption,"Economic Journal, June, 1953, 357.

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 Notes and Memoranda 97
the windows of a family home. Consciously or unconsciously they analyzed the
behaviour of the man whose views and motives are shaped by such a home and
who means to work and save primarily for wife and children. As soon as these fade
out from the moral vision of the businessman, we have a different kind of homo
ceconomicus before us who cares for different things and acts in different ways. For
him and from the standpoint of his individualistic utilitarianism, the behaviour of
that old type would in fact be completely irrational.28
28Capitalism, Socialism and Democracy (New York, 1942), 160. See also Max Weber,
The Methodology of the Social Sciences (Glencoe, Ill., 1949), 36.

ON THE EXCHANGE RISK INVOLVED IN BORROWING ABROAD

C. G. BALE
RoyalMilitaryCollege

IN the past few months tlhe Governor of the Bank of Canada has issued several
stern warnings about the dangers inherent in Canada's large current account
deficit.' He has emphasized the embarrassment which the servicing of the
large and growing external debt might present in the event of a recession or
a cessation in foreign lending, and has called for a more moderate approach
to economic development tailored to the amount of real saving which the
Canadian economy can generate.
The Governor's charge that Canada is living beyond her means was rejected
by Mr. Gordon Churchill, then the Minister of Trade and Commerce,2 but
Mr. Coyne found some support for his position in the budget address presented
to the House of Commons by Mr. D. M. Fleming, the Minister of Finance.
Mr. Fleming contended that there was no cause for alarm since Canada's
dependence on foreign capital should decline in the future. He did, however,
state that past capital inflows could create problems in the event of a deteriora-
tion in economic activity and called upon Canadians to practise thrift in order
to make Canada more financially self-reliant.3
The present note is not concerned with the weighty problems that allegedly
inhere in Canada's present balance of payments position; it undertakes only
the more modest task of analysing one particular aspect of Canada's capital
inflow. Both Mr. Coyne and Mr. Fleming have warned those who borrow
abroad of the danger of exchange rate movements. Mr. Coyne stated that:
Those who borrowvU.S. dollars now, at the present rate of exchange, put themselves
at the hazard of future movements of the rate in the other direction. Foreign cur-
rency converted now into Canadiandollars at a discount may have to be paid back,
and annual interest for many years may have to be paid, when there is a premium
on foreign currency.This is a riskwhich borrowersshould weigh against the apparent
saving in interestrates throughborrowingabroad.4
'See esp. J. E. Coyne, "Living Within Our Means," a speech delivered to the Canadian
Club of Winnipeg, January 18, 1960; and Bank of Canada, Annual Report of the Governor
to the Minister of Finance, 1959, 9.
2House of Commons Debates (unrevised), March 21, 1960, p. 2281.
3Ibid., March 31, 1960, p. 2672.
4Bank of Canada, Annual Report of the Governorto the Minister of Finance, 1956, 20.
Vol. XXVII, no. 1, Feb., 1961

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