June 22, 2024 

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AGGREGATE EXPENDITURE EQUATION: An equation indicating that aggregate expenditures (AE) are the sum of consumption expenditures (C), investment expenditures (I), government purchases (G), and net exports (X-M), stated as: AE = C + I + G + (X-M). This equation surfaces in the Keynesian economic income-expenditure model in the form of the aggregate expenditures line. However, it's also central throughout the study of macroeconomics, including aggregate demand and the measurement of gross domestic product.

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The notion that firms best suited to the economic environment on the ones that tend to survive. The natural selection of business firms is an adaptation of the biological process of natural selection, in which biological entities best suited to the natural environment are the ones that survive. The concept of economic natural selection is aimed primarily at the profit-maximization assumption. Although firms might not seek to maximize profit on a day-to-day basis, those that come closest (intentionally or unintentionally) are the ones that remain in business.
Natural selection provides an argument for presuming that business firms seek to maximize profit, even though they probably pursue other goals on a day-to-day basis. Even if firms do NOT actively, consciously pursue the profit-maximization goal, assuming they do is not necessarily unreasonable. Those firms that approximate the goal of profit-maximization, whether intentionally or accidently, are the ones most likely to survive and remain in business.

Profit Maximization?

The standard objective assigned to business firms in economic analysis is profit maximization. Firms are assumed to make the decisions, to produce the output, to hire the inputs, that generate the highest possible amount of profit.
  • If, for example, the revenue received by a firm from producing one more unit of a good exceeds the cost, then the firm produces more and in so doing increases profit. The firm continues to increase production until profit no longer increases.

  • Alternatively, if the cost incurred by a firm from producing one more unit of a good exceeds the revenue received, then the firm produces less and in so doing also increases profit. The firm then continues to decrease production until profit no longer increases.
The profit maximization assumption is a central part of the economic analysis of firm behavior underlying market supply',500,400)">market supply. With this assumption, it is possible to definitively identify the quantity of output a firm produces under alternative price and cost conditions, which is just the sort of information needed to understand market supply.

But do firms actually seek to maximize profit? Some probably do. Many probably seek other objectives.

Other Objectives

On a day-to-day basis most firms likely pursue goals other than profit maximization. Three most noted objectives are sales maximization, personal welfare, and social welfare.
  • Sales Maximization: Many firms make decisions designed to increase or maximize production and the amount of output sold. More sales mean more revenue, but not necessarily more profit.

  • Personal Welfare: Firms are occasionally motivate to increase the personal welfare of owners or employees, especially the employees who control the operation of the firm. Profit is usually sacrificed in the process.

  • Social Welfare: Some firms are also inclined to take actions that they deem will improve the overall well-being of society. These actions also tend to reduce profit.
Although firms most definitely make decisions that pursue these other objectives, the economic presumption of profit maximization is theoretical justified through the process of natural selection.

The Strongest Survive

Natural selection, as applied to the business world, suggests that firms best suited to their (economic) environment are the ones that survive (remain in business). The bottom line, literally, is that those firms generating the greatest profit are the ones most likely to continue producing. Firms that earn less (or even negative) profit are more likely to go out of the business.

Suppose, for example, the Shady Valley zucchini growing industry has 10,000 producers, most of whom are like Phil Gardener, who grows zucchinis in his backyard. Phil is a complete novice when it comes to making business decisions. Phil plants a bunch of seeds, irrigates the field, removes the weeds, throws on a little fertilizer, does his harvesting thing, then sells zucchinis to market. Phil is clueless when in comes to tabulating total production cost, let alone concepts like marginal cost that assist in the profit maximizing decision. And while he knows the price buyers are willing to pay for his zucchinis, the phrase marginal revenue, which is useful for the profit maximizing decision, has never entered his mind. He has no idea how to calculation the profit maximizing quantity of zucchini production.

Needless to say, Phil and the other 9,999 Shady Valley zucchini growers generally maximize profit ONLY by accident, NOT by design.

The end result, however, is that those zucchini growers who DO come close to maximizing profit will be the ones remaining in business. They will be encouraged by the monetary success of their zucchini activity to produce more in coming years. Those zucchini growers who DO NOT come close to maximizing profit, who produce too many or too few zucchinis, will find their zucchini growing endeavors unrewarded. They will likely leave zucchini production in favor of alternative activities (growing kumquats, sewing Wacky Willy Stuffed Amigos for The Wacky Willy Company, attending college, or whatever).

Those firms that maximize profit survive, those that do not leave the business. As such, assuming firms maximize profit, even if firms do not try to intentionally, explains their behavior quite well.


Recommended Citation:

NATURAL SELECTION, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2024. [Accessed: June 22, 2024].

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     | profit maximization | firm objectives | legal business organizations | ownership liability | firm | company | enterprise | plant | factory | industry |

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     | business | production | production cost | supply | entrepreneurship | microeconomics | private sector | institution | economic analysis | marginal analysis | market supply |

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