Frank Knight – Risk, Uncertainty, and Profit

Frank Knight – Risk, Uncertainty, and Profit

A 1921 classic in economic theory. Knight emphasizes the inadequacy of the perfect competition model. He also offers frequent psychological insights on human behavior that foreshadow today’s behavioral economics movement, though Knight lacks that movement’s ideological commitment to a top-down approach to public policy. Knight, as a student of emergent order processes, is skeptical of top-down direction as an effective way to nudge human behavior.

The book is most famous for Knight’s insights on economic change and a rejection of Walrasian static equilibrium modeling. A lot of the discussion hinges on Knight’s boutique definitions of the terms “risk” and “uncertainty.”

For Knight, risk is something that can be quantified—I know there is a 50 percent chance of such-and-such happening in the economy, and its general impact on my company, for example. Uncertainty cannot be quantified; it is a true mystery. I have invented a brand new product; will it sell?

A world of pure predictability, in which things sit in a Walrasian equilibrium, sounds comfortable. But it would have no progress or positive change. The whole reason people and companies gamble on risks and uncertainties is because they want profits—all three words in Knight’s title are essential. Standing pat won’t put food on the table. Adapting to change, and creating change, are the ways to succeed in the market.