13 Thoughts on Profit

1. Take the fundamental example of exchange. I have 10 cows, and you have 100 chickens. I have plenty of milk, but really want some eggs; you’re tired of having to eat eggs with no milk. I trade you one of my cows for ten of your chickens.

Who profits? We both do, because we voluntarily made an exchange and now we’re both better off.

2. Why should we treat (1) any differently simply because instead of ten chickens you give me fifty dollars?

3. I don’t know the answer to (2), but many of us implicitly make this leap. We’re fine with (1), but condemn the profits of large corporations. In part, this is because we are examining only one side of the transaction — we ignore our own profit.

4. Maybe you want to say the difference is that corporations are exploiting workers or the poor or the natural environment. Let’s put this issue to the side for now, that’s a post for another day. I will say briefly, though, that while these arguments are not completely without merit, they are often exaggerated or misunderstood.

5. Maybe you want to say that the exchange isn’t really voluntary at all. See the work of Mike Munger on the concept of euvoluntary exchange. Elsewhere, he has tried to extend the work of John Locke and the latter’s argument regarding the morality of certain types of transactions. Or see the blog Euvoluntary Exchange (for example, here). Again, put the specifics to the side for now.

6. Maybe you want to say it’s a matter of degree. Corporations profit much more than the individuals they are transacting with. This is the issue I want to focus on.

7. The textbook answer to (6) is that the consumer and producer surplus are determined by the elasticities of the demand and supply curves for a particular product. In English you can think of it in the following way. Through some magical process a “market price” of iPads emerges. This price is sort of like an average of what consumers as a whole are willing to pay and the price at which Apple is willing to sell. Let’s say an iPad costs $500. Note, however, that there are a small number of consumers who would have paid $1,000 for one. A few more would have paid $900, even more would buy at $800, and so on. At, say, $515 most of the people who bought an iPad at $500 still would have purchased one. You can see that all of these consumers have a “surplus.” That is to say, there is a gap between what they would have been willing to pay and the price at which they can purchase an iPad. The consumer is saving money so to speak, or, in other words, making a “profit” since they are purchasing an iPad at a cost less than that at which they value it. This is akin to Apple selling an iPad for some amount above the cost of producing it. Both consumer and producer are profiting.

In the case of the producer, though, the surplus — the difference between what Apple would have sold the iPad for and the market price — is slightly different than “profit” as the term is normally used; but you can see that the two are conceptually related. We would have to know something about the cost curve of iPad production to define the relationship exactly.

8. So knowing the shape of the demand and supply curves (and the cost curve of the producer) you could state definitively which group “profits” more. But in reality we don’t know what the shape of these curves actually looks like. We could survey consumers and ask, “Well, how much would you have paid for an iPad,” and get some sense of the demand curve for iPads. In practice, however, people aren’t so good at questions like this. They don’t really know the answer absent the context of the actual decision to purchase (or not). We would end up with a demand curve plus or minus some non-trivial error. The supply curve of producers would be more precise, but not without error itself.

9. Actually, the situation is worse than that. In practice the demand curve doesn’t exist at all, at least in a way that would allow us to determine the true consumer surplus. It’s not simply that consumers aren’t good at answering the hypothetical question regarding how much they would have paid for an iPad, but rather that this dollar amount changes over time. In six months maybe they realize the iPad is the best purchase they’ve ever made. It has allowed them to ditch their work laptop or to mobilize their electronic life in a way they never imagined. Knowing what they know now they would have paid $700 for it. Conversely, perhaps they think the iPad is just an oversized iPhone useful only for playing Angry Birds. “No more than $100, if that,” they’d say when asked.

10. Even more confounding for measuring profit is that the value of potential and already transacted purchases changes from day to day. On a sunny day I’m in a good mood, on a cloudy day I’m a little sour. This will affect the way I value various goods. In fact, anything that affects my mood will temporarily change the way I value goods. If my mother dies I can’t even conceptualize what value means for months as I focus on emotional recovery. The day after my bonus check arrives in the mail I’m probably willing to make purchases I’m not willing to make in six months after I realize the money must last the entire year. When my computer catches a virus and loses the presentation I’ve been working on for weeks I probably value it a lot less than when I lay in bed with my children and watch Finding Nemo on Netflix.

11. Again, for producers the situation isn’t quite as drastic, but the supply curve is probably more variable than we think. After all, there is some person, or group of persons, that determine what a particular item will sell for, when, and where. Though we (or at least they) would like to think the decision is emotionless and determined solely by well-analyzed consumer data, humans are humans and therefore both fallible and inconsistent.

Perhaps saying that the curves “don’t exist” isn’t quite right. I suppose it is more accurate to say that they are constantly changing and unknowable at any given time. But of the two, the demand curve is far more volatile and fleeting.

12. This is not to say that supply and demand curves are not useful. Quite the opposite, in fact. So too is the concept of rational economic behavior. The question is one of degree. Microeconomics is very good at telling us the direction of outcomes given certain inputs, but not as good at determining the magnitudes.

13. In short, to determine how much consumers profit from a transaction we have to know something about how much they value the goods being transacted, but this can’t really be determined in any meaningful way. And so the question as to whether corporations or consumers profit more for any given transaction (or group of transactions) is moot (again setting aside possible exploitation and whether the transaction is indeed voluntary).

14. Bonus thought: A graphical representation of consumer and producer surplus from wikipedia. I would argue for two additions: error margins around the curves and a third dimension to represent the inter-temporal movement of value. Perhaps neuroeconomics, behavioral economics, and microeconomic theory will one day join forces (along with sufficiently advanced technology) to produce such a graph. For now, though, we’re stuck playing Angry Birds.


The Chick-fil-A Situation and an Economics Lesson

The economics lesson will come in a moment, but first I want to talk about the situation more generally. But before doing so let me quickly reveal my biases. I am decidedly in favor of same-sex marriage. I have a lot of gay friends. I walked in Seattle’s Gay Pride parade this year. I follow George Takei on Facebook. It’s pretty much the only issue that informs my vote — not the economy, or healthcare reform, or foreign policy. I’ve never heard an argument anywhere near cogent for denying this right to same-sex couples. I also don’t remember having ever eaten at Chick-fil-A — I don’t even know where one is if I wanted to. I will certainly not be eating there in the future.

But as always our discussion of the situation lacks the clarity and precision I prefer. First, let’s state what is obviously true. Chick-fil-A did not donate money to anti-LGBT organizations. “Chick-fil-A” is an abstract human conception. It cannot donate money, just as the table in my dinning room cannot. The idea of Chick-fil-A is useful as a shorthand in many discussions and analysis, and, indeed, has specific meaning and importance in the area of law. But let’s not kid ourselves by conjuring up imagines of everyone at Chick-fil-A gathered around a drumstick shaped conference table one Monday afternoon to determine where this year’s donations would be sent. Undoubtedly, a very small group of people somewhere relatively high up, if not at the very top, made the decision about how to distribute these funds.

I say this only because I fear a certain amount of persecution for those individuals unfortunate enough to be on the front lines of the company’s franchises. I know from first hand experience that many of us know relatively little about the companies for which we work. I would not be surprised if the fry guy, or the checkout guy, or the chicken girl knew nothing of these donations before the recent brouhaha. I say this realizing that the company is outwardly religious in its mission statement. But even if employees were aware of the donations perhaps we should still cut them some slack. I doubt they were attracted to low-level positions at Chick-fil-A because of the company’s questionable values. More probably these employees have relatively few options for employment and are doing the best they can to carve out a living. Sometimes people make tough choices when their livelihood is on the line, and I for one am not going to blame them for that. Sure, some employees share the views put forward by the company’s mission statement, but I’m keeping an open mind as to which employees these might be.

On the other hand, it does seem fairly clear that these donations went to organizations that are openly hostile to same-sex marriage. You can view a complete list of Chick-fil-A recipients here. With a little poking around it seems that promoting traditional family structures is one of the core missions of these organizations. And it is troubling that their budgets are now thousands or, in one case, a million dollars richer.

Opponents have reacted just as they should — protesting, sure, but more importantly not purchasing Chick-fil-A food products. People purchase items when the price of the product is less than the expected value (or utility) they receive. But value is not utilitarian in the strict sense. Embedded in value are all kinds of non-traditional forms of utility like aesthetics, the importance of the brand, and the moral principles of the company compared to the those of the purchaser. (That’s why Apple products can garner a premium despite having nearly identical hardware components). So clearly, using this all-encompassing definition, Chick-fil-A products have lost value in light of recent events. Some have pointed out that Chick-fil-A’s values have not changed for years; but, again, what has changed is the information available in the public forum about these values. Behavior, aptly, responds to new information.

Social movements are an underappreciated aspect of capitalism, but just as surely are part of the modern capitalist system. What is unrecognized by most participants in social movements, however, is that these movements can be very good for the corporations at which they take aim. I don’t mean in some vague sense relating to free publicity and so on, I mean in a real economic sense.

Remember that $5 ATM fee Bank of America proposed charging late in 2011? An online petition against the fee was started by Molly Katchpole, a part-time nanny, and quickly gained over 300,000 signatures, causing BofA to cancel the planned increase. This seems like a victory for consumers, and in some sense it is, but it’s also a victory for BofA because they learned something about the elasticity of their ATM services. The term “elasticity” is used by economists to denote the relationship between quantity and price. If the price increases do consumers cut back a lot, a medium amount, or not at all? A high elasticity means consumers cut back a lot when price goes up. I suppose something like chocolate would be a good example because there are so many substitutes for those who have a sweet tooth. A low elasticity implies the opposite. We might think of cancer drugs as falling into this category. You’re likely to make sacrifices in other areas of your life in order to continue purchasing your cancer medication even if the price, say, doubles. In this second case, there really are no substitutes.

Firms want to charge the highest price possible without losing customers — the price that maximizes profit. But figuring out what that prices is isn’t so easy. Sure, you could do focus groups, but nothing beats 300,000 consumers collectively screaming out, “That’s too much!” “No problem,” says the bank, “we won’t charge that much.” The information embedded in these social movements is extremely valuable. Now there’s a bigger question about why a company is raising prices in the first place — maybe they are losing money or have a poor business model more generally — but elasticity information about particular services can help steer structural reforms in the business and guide executives’ decisions about the best overall method to reduce costs.

The same holds true for Chick-fil-A and the information they were able to garner. The company now has all kinds of demographic data by region (based on franchise location) showing customer loyalty and political beliefs, and can adjust local marketing campaigns accordingly if they so choose. The company also now knows roughly what percentage of total product value is due to their corporate values.Turning to the macro scale, Chick-fil-A now knows how consumers at large will respond to future charitable giving.

Overall technological improvements have caused collective action to work more quickly. Now social movements can easily garner support in days and weeks instead of months and year. But increased technology has also sped up the response time of businesses and likewise increased the sophistication with which firms can analyze the inevitable stream of data that occurs when masses of consumers willingly reveal their preferences and elasticities for particular services.

On net it’s unclear whether the companies or consumers benefit. Perhaps the loss in customers more than offsets the value of the information firms collect. Or perhaps the lost revenue from not being able to implement a $5 ATM fee will lead to more devastating cuts in other areas. Because of technology customers were able to come together and quickly bridge the information gap. Within days, millions of BofA customers knew about the proposed fees and had their outrage validated by strangers across the country. On the other hand, perhaps in the absence of a social movement there would have been a steady leakage of BofA customers away from the bank, with a policy reversal coming only after many more customers had left. The quick response from customers allowed BofA to respond equally quickly, perhaps keeping many customers that would have otherwise left.

But even if particular businesses don’t benefit the industry as a whole surely does since, for example, other major banks can us the BofA experiment to infer information about the elasticity of their own ATM services. In the case of Chick-fil-A, consumers gave a signal to businesses throughout America about the consequences of certain types of corporate giving. BofA and Chick-fil-A were “first movers” in their respective business policies. The widespread response of consumers articulated all kinds of important information to firms throughout America. This information may even counteract the reasons behind the social movements in the first place.