Pro-Human Extremist

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How businesses serve the greater good

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Hollywood is always on the lookout for good villains. The all-time greats are Nazis and Soviets, but they’re both long gone so they only work in movies set in the past, like Quentin Tarantino’s Inglourious Basterds. The current top villains are I think terrorists and big greedy corporations. The fact that corporations work so well as villains shows that lots of moviegoers are prepared to think the worst of the people who run businesses.

Given the number of corporations in our world, and the hundreds of millions (billions?) of people who work for them, it’s inevitable that their actions would sometimes harm others. But people today too seldom appreciate that the net effect of businesses in our world is overwhelmingly positive, so I figured it might help to enumerate the main positive effects that businesses have.

1) Businesses employ people

Okay, that one’s obvious. Most people in developed economies work for a business, rather than being self-employed. Jobs are good, because they help people feed and clothe themselves and their families. Businesses create jobs that wouldn’t exist if people hadn’t organized and funded the businesses, so the existence of all those businesses makes our world better. Governments create jobs too, but they’ve never managed to do so as effectively on as wide a scale as businesses.

Businesses in developing countries may pay their workers less than some folks in developed countries think is fair or reasonable, but they’re still paying more than their employees would make if they were working on farms, which is why their employees chose to work for them in the first place. Businesses open in developing countries because labor is less expensive there, and once the economy gets going wages start to rise.  Yesterday’s developing economies are today’s emerging economies, like China and Brazil, both of which have more than doubled per capita GDP just in the past ten years. Without businesses, the people in those countries wouldn’t now be on the road to affluence.

2) Businesses earn profits

This one may not seem as obviously good as the first, but consider who owns most of the bigger businesses and therefore gets a share of the profits: you and me and anyone who is saving for retirement. Pension funds are some of the biggest institutional investors today, and if the businesses they invest in didn’t make profits, those pension funds wouldn’t grow and the employees who depend on them wouldn’t get their retirement income. Those of us with defined-contribution pension plans each have much less invested than the big pension funds, but there are many millions of us, and if our portfolios didn’t grow then we too wouldn’t have enough to live on in retirement. All of us are depending on the profitability of the businesses we’re investing our money in.

But profits are bad, aren’t they? No—for two reasons. First, they seldom increase the prices of goods and services much. For the past hundred years, corporate profits have averaged about 5-10% of revenues, which means that goods and services wouldn’t cost much less even if businesses decided to give all their profits back to their customers. Second, the effort businesses make to maximize profits and prevent losses are absolutely essential to keeping businesses running efficiently. Without the profit motive to focus the thoughts and efforts of businesspeople, businesses would surely work enough less efficiently to increase the prices of goods and services above what they currently are. So we’d actually pay more for stuff if businesses weren’t allowed to earn profits! The profit motive is probably also the main reason that businesses create jobs and produce goods and services more effectively than governments have been able to.

3) Businesses create consumer surplus

Create what? Consumer surplus is the difference between how much you have to pay for something and how much it’s worth to you. If a jacket costs you $100 and you get enough use and enjoyment out of it to make it worth $300 to you, then in buying the jacket you got $200 of consumer surplus. If the jacket had been worth just exactly $100 to you, then you would have been equally happy either buying the jacket or keeping your $100—in economics-speak, buying the jacket for $100 wouldn’t have increased your utility.

The consumer surplus associated with any given purchase is difficult or impossible to measure, but the simple fact that we are glad to have bought something shows that there must be some consumer surplus, since our happiness tells us that we feel better off having exchanged our money for that good. And the actual consumer surplus for most of the things we buy is probably quite a bit more than we might guesstimate in this way, since mass-production and globalization have reduced the prices of things to well below the value in use and enjoyment that they actually have for us.

We may not think the jacket is worth much more than $100, because we can find other similar jackets for around the same price. But the real calculation of value should be based on how much benefit and enjoyment we get from any such jacket vs. having more money but no jacket. Jackets keep us warm and dry, and have pockets, and look nice. Wouldn’t you probably pay several hundred dollars at least for those services, if no jackets could be had for less? The difference between that much higher value and the paltry $100 we actually pay is the consumer surplus.

Not convinced yet? Consider the personal computer. Twenty years ago, people paid more money for computers that were way less powerful than today’s, with tiny hard-drives and essentially no internet access—yet they were still happy to exchange that amount of money for that benefit. Today’s computers are cheaper, and they give us access to a much wider range of more powerful software tools together with all of the information and enjoyment on the internet. There was some consumer surplus even in the computer purchases of twenty years ago, or the purchases wouldn’t have happened. A $500 laptop gives you so much more than $500 of value over the time you own it.

We take it totally for granted, but there’s substantial consumer surplus in all of the purchases we make. Why is this? Because businesses have competed against each other to make the design, manufacture, and distribution of goods more and more efficient. Their ceaseless efforts to make better products and to undercut each other on price benefit we the consumers, by giving us more and more consumer surplus with our purchases.

Are businesses admirable?

Okay, so businesses contribute to the greater good. But are businesses started for the purpose of creating jobs and consumer surplus, or for making possible the retirement of people who invest in them? No—they’re started by people who want to make money, and to some extent also by people who want to have fun by realizing a dream. They sell stock when they need more capital to expand, which is where the retirees come in. They create jobs because it’s hard to do much without employees, and they create consumer surplus because they’re constantly competing with each other.

So they serve the greater good merely as a means to an end or an unintended consequence of the desire to make some money. That means they don’t really deserve credit for serving the greater good, if that’s not specifically what they’re trying to do, right? Who cares—my point isn’t that businesses are morally admirable; my point is that their very existence makes our world better far more often than it makes it worse.

© Joel Benington, 2011


Written by Joel Benington

July 22, 2011 at 6:24 pm

Posted in economics, numbers

Altruism and the welfare state

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This post is really The economics of altruism III, so you may want to check out the last two if you haven’t already.

One phenomenon pondered by economists who study the economics of altruism is the welfare state. In affluent democracies, voters routinely support social safety nets that they help pay for with their tax dollars and that mostly benefit people they have never met. What motivates people to give up their hard-earned money to support total strangers?

A common explanation is a sense of justice. This supposes that we think it’s wrong for some people to have much more than others, even if we are among the people who have more. So we’re in favor of government taxing affluent people more, and using the extra money to help out the disadvantaged.

Another possible explanation is a kind of insurance policy. While we may be doing fine right now, our lives could sometime take a turn for the worse. By voting in favor of a social safety net, our higher taxes now are buying insurance against some future catastrophe in our own lives.

Either or both of these explanations may indeed help explain this curious phenomenon. But can it also be explained simply in terms of other people’s utility factoring into our own utility functions?

Consider how the transactions of a welfare state work. The extra taxes you pay lower your total consumption (xi from the equation in The economics of altruism). Your contribution is added to those of a great many other taxpayers, all of whom presumably are doing reasonably well or they would be net recipients of the welfare-state payout. The money collected from you and all the other taxpayers goes to people who presumably need it more than the people who are contributing the taxes do.

So your money isn’t a one-off payment that goes to a complete stranger in need. By voting in favor of a welfare state you ensure that everyone else pays too, in proportion to their ability to pay. Your share is just a tiny part of a much greater sum that can then be distributed to the needy, and increase their utility.

In the personal utility function that describes this situation, one factor is your own consumption, which is decreased by some amount depending on how much you are taxed to support the welfare state. The other factor is a set of the utility functions of all of the other people who pay taxes and/or receive benefits. There’s an equation for this utility function, but I won’t bore you with it.

Since the people who pay into the welfare state are all fairly affluent, the loss to their own consumption shouldn’t decrease their utility all that much. Since the people who benefit from the welfare state are more needy, the money that is transferred to them should produce a proportionately greater increase in their utility. The welfare state thus causes a lot of people to experience a small decrease in utility and a lot of people to experience a correspondingly greater increase in utility. Even though the vast majority of them are unknown to you, you know it’s happening because it’s been legislated and will be enforced.

What, then, is your trade-off in deciding whether to cast your vote in favor of a welfare state? One factor in your utility function is your own loss of consumption as a result of the taxes you pay. The other factor is the value to you of the increased utility of millions of complete strangers (the beneficiaries), against the much smaller decreased utility of another group of millions of complete strangers (the other taxpayers). Even if the well-being of each of these complete strangers factors only very weakly into your utility function, the sheer number of the people benefited by the welfare state may be enough to make you feel that your utility is increased by the existence of that welfare state, even though you have to pay some taxes to support it.

This line of reasoning can explain popular support for a welfare state without invoking a sense of justice, or a desire to insure against the future, or any other motivation. It can come down simply to a rational economic calculation by a person who derives some small value from the well-being of others. Given the number of people involved, that value can in fact be quite small and still outweigh the cost that they themselves have to pay in taxes.

I know, I know—there are arguments against a welfare state too. It may create inefficiencies, the higher marginal tax rates may discourage economic activity that would otherwise benefit everyone, it may create perverse incentives for the less well-off. But all that is a conversation for another day. My only point here is that we can explain the existence of a welfare state merely by supposing that voters have utility functions in which other people’s utility is a component.

© Joel Benington, 2011.

Written by Joel Benington

June 8, 2011 at 7:32 pm

Posted in altruism, economics, numbers

Using the economics of altruism

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In the last post, I described how altruistic behaviors can be explained economically, in terms of utility functions where the two goods are our own consumption and another person’s utility. An indifference map based on such a function would predict altruistic actions any time we can give up some of our own consumption to increase another person’s utility enough that the new combination of our consumption and their utility that has a higher utility for us. If we can buy enough increase in their utility at a low enough cost to ourselves, we’d make that trade. How about some examples of this?

Say you run into a complete stranger who’s really thirsty and is one quarter short of the cost of a drink in a vending machine. No stores are open, so the vending machine is their only hope. Would you give them a quarter so they can slake their thirst? They’re a complete stranger, so you’re never going to get your money back or get any intangible rewards from them for your generous action, other than hopefully a hearty thanks. But the cost to you is small and the benefit to them may be disproportionately great. Does their utility factor strongly enough into your utility function that you would trade a small amount of your own consumption (however much you could buy with a lousy quarter) to make them better off?

I’m too polite to ask for your answer, but while you’re mulling it over I do want to acknowledge that the cost of the quarter may reward you in other ways, besides the increase in the other person’s utility. Humans are complex social animals, and all sorts of emotions about giving and receiving are programmed into us by some combination of genetic and social influences. Being generous in this situation may raise your self-esteem, and that may cause you pleasure. If you don’t give a quarter, you may violate some ingrained moral norm about helping out people who are in need, and that may cause you to feel guilty. Or you may be influenced by the slight chance of other people hearing about what you did in this situation.

Any of those motivations could factor into your decision. So if you do give that poor thirsty person a quarter, we can’t be positive that their utility does indeed factor into your utility function. But your actions can be explained in terms of the value to you of their utility—in terms of altruism. I emphasize this because some people delight in undercutting the idea of altruism by pointing out that these other motivations exist. But that fact by no means rules out that altruism is also a bona fide human motivation, and may explain a lot of what we do.

Another nice example is the ads you’ve probably seen showing deprived children in tropical countries that you can help feed for just pennies a day. You don’t know these children and probably never will, but the ads promise that a small decrease in your own consumption will dramatically increase their utility. Would you make that trade? Would that new combination of their utility and your consumption increase your own utility?

This example illustrates the well-established economic principle of diminishing marginal utility: if you have almost no money, then a dollar increases your utility more than if you already have a lot of money and get one dollar more. Pennies a day would increase the child’s utility far more than losing the same number of pennies would decrease yours, if you’re a fairly affluent member of a developed economy. So even though the child is a perfect stranger, you can buy a lot of their utility with a relatively small cost to your own consumption, which means the trade-off may increase your utility even if the well-being of a perfect stranger isn’t vitally important to you (a.k.a., only weakly factors into your utility function).

But if it’s really just the child’s utility that is motivating you, then you should be almost as likely to pony up to support a second child, and a third, and so on until you’ve given up so much money that a further loss of consumption would actually reduce your utility more than it would be increased by the knowledge that a child somewhere has been fed. That would happen eventually if you kept on giving. Each donation leaves you with less money than before, so each bit of money you give up should lower your utility more than the last one did. (That’s the principle of diminishing marginal utility in reverse, by the way.) But what are the chances that after just one donation you’d reach that critical point where the next donation wouldn’t be worth it to you? That would imply that you had been at a point where your loss of money and the child’s gain of food had almost exactly equal value in your utility function.

My hunch is that the vast majority of people contribute enough in these campaigns to support a single child and then stop, which implies that there are other motivations at work—not necessarily to the exclusion of a sincerely altruistic motivation, but at least in addition to one. People  may benefit from the boost to their self-esteem of knowing that they were generous enough to help out a needy child, and that benefit may more or less max out after one donation. A second donation would have to be motivated only by the value of a second child’s well-being, which may not be quite enough to balance the loss of consumption in their utility function. Or a picture of one starving child may only help the average person derive utility from the thought of one child being given food, and their imagination may not extend to a second. Or a single donation may be small enough that they don’t feel the need to carefully weigh the costs and benefits to themselves of making it, whereas giving in quantity may call for a deeper self-examination that they may not be up for at the moment. Truly, the human heart is mysterious and complex!

© Joel Benington, 2011.

Written by Joel Benington

June 2, 2011 at 6:45 pm

Posted in altruism, economics, numbers

The economics of altruism

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Economists get a bad rap for assuming in their models that people are only interested in themselves. The much-maligned Homo economicus uses all information at their disposal to make decisions that maximize their own well-being, or what economists call utility. But actually, some economists have described how altruism can fit neatly into the equations that are used to describe utility.

Utility functions and indifference maps describe what combinations of two goods a person has a higher or lower preference for. The goods could be anything we would spend money on or make an effort to get—for example, pizza and beer. Let’s say you have a six-pack of beer and a slice of pizza. If you’d rather have five beers and two slices of pizza, then that combination would have a higher utility for you, and you ought to be willing to trade one of your beers for a second slice of pizza.

The three lines on this indifference map are called indifference curves. Each one describes combinations of the two goods that produce equal utility for a given person, so that person should be indifferent as to which particular combination along that curve they get. The combinations on curve I2 produce higher utility than the combinations on curve I1, and the combinations on curve I3 produce even higher utility.

If we say Good Y is beer and Good X is pizza, then the example I gave above would make sense if five beers and two slices of pizza were on indifference curve I2 and six beers and one slice of pizza were on indifference curve I1, so by trading a beer for a slice of pizza, you could go from a situation of lower personal utility to one of higher utility.

In this example, the two goods are material things (pizza and beer), but they could also be something immaterial—like free time, for example. When we accept a wage for doing a job, we are trading some of our time and effort for a certain amount of money. If the wage is high enough for us to take the job, that trade-off must produce a combination of time and money with higher utility than the combination of more free time and less money that we had before we took the job.

The economists who study altruism have applied these principles to examples in which one of the two goods is another person’s utility. The most basic form of that sort of utility function is:

       Ui (Uj,xi)

This expresses that my utility (Ui) is a function of a trade-off between the utility of some other person (Uj) and the totality of my own consumption (xi). In other words, if I do indeed care about another person’s well-being, then I should be willing to give up something (money, time, etc.) to make their life better. And an indifference map where their utility and my consumption are the X and Y axes should be able to describe what combinations I prefer of a certain amount of my own consumption and a certain level of their utility. As a rational economic actor (Homo economicus), I should only be willing to trade some amount of my own consumption to increase that other person’s utility, if the new combination of my own consumption and their utility moves my situation from an indifference curve of lower personal utility to one of higher personal utility.

This means that basic economics can account for altruistic behaviors, simply by assuming that other people’s utility factors into our own utility functions. We can be Homo economicus and still care about what happens to the other people in our lives. Helping other people increases our own utility, but it’s still an altruistic act as long as our sincere motivation is to help another person. Cool, no? In the next post, I’ll consider some examples of this.

© Joel Benington, 2011.

The above image is used under a Creative Commons Attribution ShareAlike 3.0 license.

Written by Joel Benington

May 26, 2011 at 6:18 pm

Posted in altruism, economics, numbers