Richard E. Bauer Blog: Economics is messy

We still teach a lot of myths in the intro to economics course, myths that spill over to conventional wisdom.

Human beings make rational decisions in our considered long-term best interest.

Actually, behavioral economics shows us that people almost never do this. Our decision-making systems are unpredictable, buggy and often wrong. We are easily distracted, and even more easily conned.

Every time we assume that people are profit-seeking, independent, rational actors, we've made a mistake.

The free market is free.

The free market only works because it has boundaries, rules and methods of enforcement. Value is created by increasing information flow and working to have as many contributing citizens as possible.

Profit is a good way to demonstrate the creation of value.

In fact, it's a pretty lousy method. The local water company clearly creates more value (in the sense that we can't live without it) than the handbag store down the street, and yet the handbag store has a much higher profit margin. That's not because of value, but because of mismatches in supply and demand, or less relevant inputs like brand, market power and corporate structure.

Profit is often a measure of short-term imbalances or pricing power, not value.

I hope we can agree that a caring nurse in the pediatric oncology ward adds more value than a well-paid cosmetic plastic surgeon doing augmentations. People with more money might pay more, but that doesn't equate to value.

The best way to measure value created is to measure value, not profit.

The purpose of society is to maximize profit

Well, since profit isn't a good measure of value created, this isn't at all consistent. More important, things like a living wage, sustainability, fairness and the creation of meaning matter even more. When we consider how to advance our culture, "will it hurt profits?" ought not to be the first (or even the fifth) question we ask.

The price of a stock represents the value of the company.

It turns out that the price of a stock merely reflects what a few people decided to trade it for today. Tomorrow, it will certainly be different, even if nothing about the company itself changes.

There's very little correlation with how the traders come to value a company in the market and how much value a company actually creates.

The only purpose of a company is to maximize long-term shareholder value.

Says who? Is the only purpose of your career to maximize lifetime income? If a company is the collective work of humans, we ought to measure the value that those humans seek to create.

Just because there's a number (a number that's easy to read, easy to game, easy to keep track of) doesn't mean it's relevant.