RISK UNCERTAINTY AND PROFIT KNIGHT F. Księgarnia

This book remains one of the most interesting readings in economics available.

Frank H. Knight was one of the founders of the so-called Chicago school of economics, of which Milton Friedman and George Stigler were the leading members from the fifties to the eighties. Knight made his reputation with his book Risk, Uncertainty, and Profit, which was based on his Ph.D. dissertation. In it Knight set out to explain why perfect competition would not necessarily eliminate profits. His explanation was "uncertainty," which Knight distinguished from risk. According to Knight risk refers to a situation where the probability of an outcome could be determined, and therefore, the outcome could be insured against. Uncertainty, by contrast, referred to an event whose probability could not be known. Knight argued that even in long-run equilibrium, entrepreneurs would earn profits as a return for their putting up with uncertainty. Knight's distinction between risk and uncertainty is still taught in economics classes today. Knight made three other important contributions to economics. One was The Economic Organization, a set of lecture notes originally published in 1933; his famous article, "Some Fallacies in the Interpretation of Social Cost; " and his work on capital theory in the thirties.

Knight was an economics professor at the University of Chicago from 1927 until 1955, after which he was emeritus professor until his death.

Table of Contents

PART ONE: INTRODUCTORY

Chapter I.

The Place of Profit and Uncertainty in Economic Theory

The nature and necessity of a deductive science of economics -- Analogy of physical science -- Necessity of emphasizing the abstract character of hypotheses -- Thought means analysis and analysis abstraction -- The assumption of perfect competition -- Profit absent -- The conditions of perfect competition include especially perfect knowledge, and profit is to be explained by uncertainty -- Plan of the book

Chapter II.

Theories of Profit; Change and Risk in Relation to Profit

Historical sketch of the treatment of profit in economic literature -- Special consideration of the Dynamic and the Risk theories -- The former confuses the effects of change with those of the uncertainty connected with change -- The latter falls into confusion by failing to distinguish between risk in the sense of a measurable probability and an uncertainty which cannot be measure -- Change according to a known law does not give rise to profit, nor does risk if measurable, since it can be eliminated by insurance or some equivalent device.

PART TWO: PERFECT COMPETITION

Chapter III.

The Theory of Choice and of Exchange

Wants, and the economic order as a mechanism for organizing want-satisfying activity -- Conflict of wants -- Resources, and their use to satisfy a plurality of wants -- Utility and Diminishing Utility -- simple choices; the boy and the berries; Crusoe and the Crusoe economy; the production and exchange of goods under simplified social conditions -- The problem that of combining alternatives -- Pleasure and pain relative -- Cost is a sacrificed alternative -- The true significance of resources and resource costs -- Formulation of the relations in functions, curves and equilibria.

Chapter IV.

Join Production and Capitalizatio

The use of a plurality of kinds of resource in producing various commodities and the resulting problem of organization -- The law of diminishing returns, analogue of the law of diminishing utility -- The imputation of product-values to resources or oust goods and resultant placing of the latter to maximize their yield -- Critique of the productivity theory -- The values of productive services in terms of demand and supply -- No valid classification of productive agencies into "factors" is possible -- The role of time in production and the fallacy of time preference.

Chapter V.

Change and Progress with Uncertainty Absent

The meaning of static conditions and the forms of progress -- Question of classifying productive agencies along conventional tripartite lines -- Changes in supply and demand of productive goods and in the distributive shares -- Question of progress toward equilibrium levels -- All modes of progress represent alternative methods of investing present resources for a future gain -- With uncertainty absent the rate of return would be equal in all these fields -- Contrast with present facts -- The nature of interest as a peculiar form of income, distinguishable from rent.

Chapter VI.

Minor Prerequisites for Perfect Competition

Brief consideration of conditions requisite for perfect competition other than the absence of uncertainty -- Divisibility of elements in the adjustment -- Lack of moral connotation of the term "productivity" -- Monopoly; various forms; is productive in the economic sense -- Tendency of a competitive system toward monopoly and a universal dead-lock.

PART THREE: IMPERFECT COMPETITION THROUGH RISK AND UNCERTAINTY

Chapter VII.

The Meaning of Risk and Uncertainty

Outlines of a theory of knowledge -- The role of consciousness in behavior -- Conduct in forward-looking and the problem of knowledge is prediction -- Knowledge of the future depends on the fact that expression can be analyzed into the behavior of objects which maintain their identity -- But there are too many of these for our intelligence to handle, so we depend on inferring one mode of behavior from another, i.e. upon constancy in association of properties -- Generally speaking, exhaustive and quantities analysis is impossible, and we "estimate" -- Commonly there is a diversity in the possible modes of behavior to be inferred, and we reason in terms of "probability" of various outcomes -- Probability a priori vs. statistical -- Errors in judgment usually not susceptible to objective evaluation on any ground, though they are estimated as probabilities -- The "risks" which give rise to profit are chiefly of the nature of chances of error in judgment, and hence not measurable, because too unique to form into classes.

Chapter VIII.

Structures and Methods for Meeting Uncertainty

Attitudes toward uncertainty -- Variable factors -- Free enterprise -- The economic organization deals with uncertainty by reducing it or specializing the function of meeting it -- The chief method of reduction is by consolidation, though important structures exist for perfecting information and for the direct control of the future -- Insurance the chief device for consolidation -- Speculation specializes risk, but is fully as important as a means of consolidation -- Large-scale operation, especially the corporation -- Promotion.

Chapter IX.

Enterprise and Profit

Introduction of uncertainty into a perfectly equilibrated static society -- Specialization of the function of management and risk-assumption -- Contractual income and residual income -- Conditions which control the amount of the profit share, chiefly timidity or, optimism of entrepreneurs, specially in estimating their own powers -- Supply and demand of entrepreneur ability.

Chapter X.

Enterprise and Profit (continued) The Salaried Manager

Indirectness of knowledge and control -- We generally judge the capacity of someone else to judge for us and not our problems itself -- In the same way we get things done by getting to do them -- The characteristic quality of the executive is judgment of men -- The final control is the selection of men to control in business organization, and this is inseparable from responsibility -- The distribution of authority and responsibility in the modern business word.

Chapter XI.

Uncertainty and Social Progress

Change, the main source of uncertainty, is the source of the problem of control -- Uncertainty in the investment of resources give rise to a separation of the function of investment from that of saving -- The theory of interest -- The uncertainty element in relations to the various forms of progressive change -- Complicated problems arising out of the capitalization of profits -- The permanence of profit; friction and mobility.

Chapter XII.

Social Aspects of Uncertainty and Profit

All methods of reducing or redistributing uncertainty involve costs The extent to which they should be carried depends upon how far uncertainty as such is undesirable Free enterprise concentrates control and responsibility in the hands of property-owners, and a small class of these Contrast between free enterprise and freedom From the standpoint of efficiency alone it is fairly clear that men work more interestedly and effectively for an uncertain than for a certain reward Question of the aggregate amount of the profit share All evidence indicates that it is negative Question of abolishing free enterprise in favor of some other system Largely a problem of getting those in control of economic activity to feel an independent creative spirit The great difficulty of control beyond one's own life-time; social continuity and the family problem.

880 pages

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