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Reading :: Risk, Uncertainty, and Profit

Posted by: on Oct 9, 2015 | No Comments
By Frank H. Knight

This 1921 classic argues that to understand profit, we must recognize the roles of risk and uncertainty. The difference, he proposes, is that risk is quantifiable (think in terms of actuarial tables); uncertainty is qualitative and unmeasurable (pp.19-20). "It is this 'true' uncertainty, and not risk, as has been argued, which forms the basis of a valid theory of profit and accounts for the divergence between actual and theoretical competition" (p.20).

In Ch. 2, Knight reviews theories of profit. Of special interest to me is his assessment of Marx's contribution, which he dismisses: Marx's understanding of profit was "narrowly literal... wholly uncritical and superficial" (p.27). Thus "they derive a simple classification of income in which all that is not wages is a profit which represents exploitation of the working classes" (p.28).

Knight lists five ways to deal with uncertainty:
1. Consolidation
2. Specialization (including speculation)
3. Control of the future
4. Increased power of prediction (p.239)
5. Directing industry to areas of less uncertainty (p.240).

Knight concludes: "Profit arises out of the inherent, absolute unpredictability of things, out of the sheer brute fact that the results of human activity cannot be anticipated and then only in so far as even a probability calculation in regard to them is impossible and meaningless" (p.311).

Should you read this book? I'm no economist, but I found it easy enough to follow, and for me, the thesis was provocative. Naturally, I like the idea of profit emerging from unquantifiable uncertainty, and the criticism of Marx seems plausible to me. If you're interested in the question of profit, take a look.