Microeconomics,, 16th Canadian Edition

(Sean Pound) #1

Although assumptions are an essential part of all theories, students are
often concerned about those that seem unrealistic. An example will
illustrate some of the issues involved. Much of the theory that we are
going to study in this book uses the assumption that owners of firms
attempt to make as much money as they can—that is, to maximize their
profits. The assumption of profit maximization allows economists to make
predictions about the behaviour of firms, such as “firms will supply more
output if the market price increases.”

Profit maximization may seem like a rather crude assumption. Surely, for
example, the managers of firms sometimes choose to protect the
environment rather than pursue certain highly polluting but profitable
opportunities. Does this not discredit the assumption of profit
maximization by showing it to be unrealistic?

The answer is no; to make successful predictions, the theory does not
require that managers be solely and unwaveringly motivated by the
desire to maximize profits at all times. All that is required is that profits
be a sufficiently important consideration that a theory based on the
assumption of profit maximization will lead to explanations and
predictions that are substantially correct. It is not always appropriate to
criticize a theory because its assumptions seem unrealistic. A good theory
abstracts in a useful way; a poor theory does not. If a theory has ignored
some genuinely important factors, its predictions will usually be
contradicted by the evidence.

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