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1.2 MINIMIZATION OF THE SUBJECTIVE PROBABILITY OF ECONOMIC EXTINCTION

If we admit that the economic criterion arises as a result of Darwinian natural selection, every successful economic agent (i.e. every agent that survives in the long run) tries (at least intuitively) to avoid situations involving a high risk of extinction. Therefore, we have chosen minimization of the (subjective) probability of extinction as the agent's general decision-making criterion. It can be assumed that in a liberal market environment such a criterion will be established by natural selection: agents that do not behave in this way will become extinct.

If a decision-taker feels that a low amount of funds is the sole threat to his existence, he will react to this threat with economic behaviour that can be explained using the standard neoclassical homo economicus paradigm, i.e. he will maximize his profit or disposable income.

If the individual feels that inferior social status is part of the threat, he will endeavour to increase his social prestige (i.e. to augment his human and social capital, in Becker's terminology). A non-profit university threatened by loss of accreditation because professors are leaving their posts will reduce this risk by increasing their pay. An individual who feels that a threat to other members of society is a threat to society as a whole and therefore also to himself will eliminate this perceived threat by behaving altruistically in society.

An economic agent usually faces not just one threat, but numerous different ones. If a producer's profit is too low, its owner may depart or it may go bankrupt. If its wages are too low, its employees may quit or the quality of its workforce may fall too low. If its price is too high, its sales may be too low. If its share of the market is too small, it may not be able to sign a sales agreement with a monopsonistic buyer. Its managers may instinctively reject a rapid change in production conditions as an inestimable risk. From the manager's point of view, operating at the upper limits of the firm's production capacity (on the production function) may be risky: if the parameters of the firm's economic situation (which the manager cannot fully control) change only slightly, he will not be able to meet the owners' expectations and he may risk losing his lucrative position in the firm and his reputation as a successful manager (for example for failing to deliver the expected profit).

The various threats perceived by a decision-taker or a group (managers, employees, owners) involved in settings the economic agent's criterion are often simultaneous and sometimes contradictory. If an agent knows how to estimate his probability of economic extinction for each individual threat, he can combine those probabilities (for example by summing them if the threats are mutually independent), thereby converting all the threats into a single scalar cardinal criterion, namely the probability of extinction of the agent due to materialization of any of the threats under consideration. Such a criterion, combining all the threats perceived by the decision-taker, then often leads to the optimal solution within the set of feasible solutions of the model. This optimal solution is often a trade-off.

Suppose that an agent's survival (or the threat to his existence) depends solely on his income, or rather on his income relative to the subsistence level: the closer the agent is to the subsistence level, the higher is his probability of (economic) extinction and so the stronger is his subjective feeling of being personally threatened.

Like profit (but unlike consumer utility), the subjective probability of personal survival is a cardinal utility function. In deterministic models we can get by with an ordinal utility function. However, in situations of a stochastic nature (such as the St Petersburg paradox covered in Chapter 2 or the principal-agent problem discussed in Chapter 3) we cannot get by with an ordinal utility function and we can view a cardinal criterion as being an advantage in this regard.

In most chapters we will assume that the subjective probability of survival is directly proportional to the margin relative to the boundary of the extinction zone (i.e. relative to the subsistence level). This assumption is consistent with an asymmetric Pareto probability distribution.

 
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