Marginal Utility, Interest and Profit

Humans decide what to do and what not to do based on the sum of utility they think they'll get from doing it. The difference between the utility of doing a thing now versus doing the same thing a certain span into the future gives rise to so-called interest, or the difference between what one will give up in the present versus what one would like to get back when that future time arrives. If this value ends up being positive after all costs are factored in then profit has taken place.

So let's meet these three sexy concepts and put some meat on their bones!

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MARGINAL UTILITY

Marginal utility is a lovely abstraction to explain how humans decide between possible means and ends. Basically utility is feelings of satisfaction which can be understood as either actively positive feelings or just the escape from negative feelings of unease.

The utility that humans can gain from satisfying their wants has an ordinal ranking, a utility function or value scale, whereby any given potential action (means) and its outcome for the person in question (ends) will be measured against all the other potential actions and outcomes including inaction.

If you ever want to do serious microeonomics you have to engage with marginalism, even if you end up disagreeing with it, because it's by leaps and bounds the most rigorous explanation of the origin of choices when motivated by one's unlimited wants versus the limited means by which to satisfy some of those wants.

The utility of any given action that a person might undertake can be thought of as net utility, like net income (profit) on a balance sheet. Yeah, I think you know where I'll be going in the profit section below. But net utility? Why not gross utility? Because disutility is a thing, in fact three things!

The three disutilities of marginalism are;

1. Labour - the effort required to perform the actual means themselves and achieve the ends
2. Diminishing returns - declining marginal utility of every additional unit of the ends achieved
3. Opportunity cost - net utility of alternatives foregone versus the action taken

Between them these three disutilities also help us to explain substitution, the process whereby a person's preference shifts from Good X to Good Y because the labour involved or opportunity cost of consuming Good X increases.

Substitution is also the reason that indifference isn't really a problem for the scholar of economics. Indifference refers to a situation in which a person values two different packages of goods equally, theoretically leaving no means with which to decide between them. But substitution and indifference can have their day in the sun later.

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INTEREST

Interest rates are simply the difference between what a particular person gives up in the present and what they expect to get back in the future. There is an obvious experiential gap between the more or less certain present and the uncertain - as yet unexperienced - future.

Since humans are emotional individuals, each caught inside their own body with their own subjective frame of reference, they will prefer what is certain to what is uncertain, with preference decaying as uncertainty increases. Thus, certainty about the likelihood of getting back what they give away will determine the interest rate at which they give it away.

For example, Able gives Bumble $100 to pay back a year later. Able charges interest of $25 so that, a year later, Bumble owes Able $125, not $100. Able values $100 at the time of lending more than $100 in the abstract future a year later as viewed from the time when he lent the money.

Therefore he jacks up the quantity to be returned above $100 with the difference - the interest rate - equal to his preference for a future return as compared against the $100 he's giving away now. This means he values $125 a year in the future equally to $100 in the present.

This can be referred to as time preference, and the rate of interest is equivalent to the time preference of the individual giving something away in the present, like Able and his $100.

The above example doesn't account for a marketplace in lending, which adds supply and demand to the individual calculus described above, but we have the basics down. A later post will deal with the big four theories of interest.

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PROFIT

To profit from an act is to get more out than you put in to that act.

Profit, viewed from an accountancy point of view, is income net of all outgoings, just as the utility of actually taking an action and its consequences is the total utility of the action viewed beforehand minus the three disutilities described above.

Therefore material profit from taking actions is analogous to the psychic profit of positive net marginal utility. This makes profit as a cardinal quantity on a balance sheet and as an ordinal improvement in psychic well-being intimately tied up in each other.

When people complain about profits being too high, or the profit motive being destructive, they're talking about the urge to move from a less satisfactory state to a more satisfactory one, to get more out than one puts in, to even function as a human being.

Or any animal, actually. All animals act to assuage present unease and replace it with satisfaction in some way. Biological forms of unease include hunger, pain, fear, anger, lustfulness, and so on.

The only difference with humans is that we can apply more cognitive nous to deciding between different things we could eat, different ways to alleviate a present pain, attacking the source of our anger or meditating it away, and choosing between different potential sex acts, and so on.

So profit is good because it gives a human-being something to aim for. Trying to abolish it is bizarre and relies on abolishing the urge to get more out than you put in.

Enjoy capitalism!