<p>A firm has a business plan. From its perspective, resources are allocated “correctly” if they achieve its business plan. However, it is entirely possible that the business plan makes no sense, e.g., it is supplying a product far in excess of what customers are willing to buy. For public companies, equity market analysts attempt to project the effectiveness of those business plans. The volatility of equity prices is an indication that this is not easy.</p>
<p>A single project is typically evaluated with discounted cash flow analysis. (Similar to this question answer: <a href="https://economics.stackexchange.com/questions/40077/if-the-government-builds-a-bridge-how-do-we-know-its-the-best-possible-usage-o">government analysis)</a> This gives us a project-level profitability measure, but we really need to evaluate the global business plan.</p>
<p>The issue is that “profitability” is somewhat vague: on what horizon? It is entirely possible for a firm to invest in projects to build capacity but those initial projects have very low profits (or even losses) during its growth years. However, the hope is that the firm is very profitable when it has reached its target size. Unless we wait, we cannot be sure whether this strategy will generate future profits or not.</p>

CC BY-SA 4.0
2020-10-08T19:36:37.693Z
Hey, thanks Brian. I clarified my description above to make it cleaner. Can you edit your answer to more directly take on part 2 of my question? Sorry if it was unclear originally.
David
CC BY-SA 4.0
2020-10-08T22:35:29.810Z
This question is marked as answered, which I am not sure about. However my answer to part 1 is that in the real world, we cannot really measure whether resource use is efficient without looking at the business plan. Amazon was famously unprofitable for a long time - were they inefficient? As such, your second question does not apply. If you want to ask this question, you really need to narrow it down. As the comments noted, it’s basically a good portion of microeconomics.
Brian Romanchuk
CC BY-SA 4.0
2020-10-08T23:42:00.053Z
How is my 2nd question too broad? Somebody literally asked a question yesterday called: "How Are Expected Costs and Benefits Distinct from Ethical and Moral Judgments?" -- And got multiple answers. It doesn't logically make sense to entertain that question, but not entertain mine. I just want somebody to humor me & take a stab at my question... if somebody really understood the topic well, they'd be able to give me a succinct answer...
David
CC BY-SA 4.0
2020-10-08T23:46:21.127Z
Also thanks Brian for the nice, calm comment above. I'm honestly trying my hardest to ask the most precise + narrow questions possible (but still hard to answer :) ). But I feel like I'm getting my head ripped off for some reason :/
David
CC BY-SA 4.0
2020-10-09T01:36:10.100Z
I don’t understand the hostility to this question. It is broad, but it seems that there would be at least a short explanation to point in the right direction. I have zero interest in microeconomics, so I can’t help you. Part of the issue might be that you asked a few questions with the same theme in short order.
Brian Romanchuk
CC BY-SA 4.0
2020-10-08T12:01:40.287Z
2020-10-08T12:01:40.287Z
Brian Romanchuk
<p>To clarify, it's a two part question:</p>
<ol>
<li>How do we know a business allocates resources efficiently?</li>
<li>Assuming the answer to above is: &quot;profitability&quot; Why is is 'monetary' profitability taken to be synonymous with efficiency of resource allocation?</li>
</ol>

CC BY-SA 4.0
2020-10-08T19:32:12.000Z
Not quite, because my question has two parts. And the 2nd Q is not touched on by the earlier govt/bridge answer you linked above. The 2nd Q is the harder one. I edited my description above to make it crystal clear what I'm wanting to know.
David
CC BY-SA 4.0
2020-10-08T19:48:14.120Z
Businesses don't allocate resources per se all on their own. The market (through the price mechanism) allocates resources. Zooming into one firm creates confusion in this sense.
BB King
CC BY-SA 4.0
2020-10-08T19:57:59.653Z
That's what I'm wondering -- (and have made clear many times now) -- why is maximization of profitability considered to be synonymous with efficiency of resource allocation? That is implicit in your explanation of the 'price mechanism' allocating resources.
David
CC BY-SA 4.0
2020-10-08T20:18:34.693Z
@Davis Clute that is a pretty broad question. Usually it would take a class the whole semester to properly go through, in my experience. Try narrowing down your question.
BB King
CC BY-SA 4.0
2020-10-08T20:22:17.110Z
You could argue it's too deep to answer succinctly, but it's not too broad. I'd like to see someone take a stab at it, or I will take a stab myself.
David
CC BY-SA 4.0
2020-10-08T20:25:58.410Z
There is a whole branch of economics dedicated to this question and many books that have already taken a stab at it. They're out there, just read them.
BB King
CC BY-SA 4.0
2020-10-08T20:29:16.227Z
Just because there's books out there doesn't mean I can't ask a question...agreed? Also, I would actually be curious for any literature on the subject if you have specific sources in mind. Friedrich von Hayek is hard to understand...very academic writing style...
David
CC BY-SA 4.0
2020-10-08T20:40:34.310Z
You can ask questions, but this website is for very specific narrow questions. You can't just ask: Explain the whole book to me. This just isn't the right place, sorry about that.
BB King
CC BY-SA 4.0
2020-10-08T20:42:44.703Z
...? -- Anyways, if you would like to point me towards some books/resources speaking to this specific topic, I'd greatly appreciate it. The more contemporary the better. Hayek, Menger, Mises are hard to read...
David
CC BY-SA 4.0
2020-10-08T21:13:37.147Z
Ideally start with Hal Varian's Intermediate Microeconomics.
BB King
<macroeconomics>
How do we know a business is allocating resources correctly? If the answer is 'profitability,' why is monetary profitability the barometer?
David
# How do we know a business is allocating resources correctly? If the answer is 'profitability,' why is monetary profitability the barometer?

(Asked by: username_0 on 2020-10-08)

To clarify, it's a two part question:

1. How do we know a business allocates resources efficiently?
2. Assuming the answer to above is: "profitability" Why is is 'monetary' profitability taken to be synonymous with efficiency of resource allocation?

**Tags:** macroeconomics

> **Comments:**
> **username_0**: Not quite, because my question has two parts. And the 2nd Q is not touched on by the earlier govt/bridge answer you linked above. The 2nd Q is the harder one. I edited my description above to make it crystal clear what I'm wanting to know.  
> **username_1**: Businesses don't allocate resources per se all on their own. The market (through the price mechanism) allocates resources. Zooming into one firm creates confusion in this sense.  
> **username_0**: That's what I'm wondering -- (and have made clear many times now) -- why is maximization of profitability considered to be synonymous with efficiency of resource allocation? That is implicit in your explanation of the 'price mechanism' allocating resources.  
> **username_1**: @Davis Clute that is a pretty broad question. Usually it would take a class the whole semester to properly go through, in my experience. Try narrowing down your question.  
> **username_0**: You could argue it's too deep to answer succinctly, but it's not too broad. I'd like to see someone take a stab at it, or I will take a stab myself.  
> **username_1**: There is a whole branch of economics dedicated to this question and many books that have already taken a stab at it. They're out there, just read them.  
> **username_0**: Just because there's books out there doesn't mean I can't ask a question...agreed? Also, I would actually be curious for any literature on the subject if you have specific sources in mind. Friedrich von Hayek is hard to understand...very academic writing style...  
> **username_1**: You can ask questions, but this website is for very specific narrow questions. You can't just ask: Explain the whole book to me. This just isn't the right place, sorry about that.  
> **username_0**: ...? -- Anyways, if you would like to point me towards some books/resources speaking to this specific topic, I'd greatly appreciate it. The more contemporary the better. Hayek, Menger, Mises are hard to read...  
> **username_1**: Ideally start with Hal Varian's Intermediate Microeconomics.  

---

## 1 answers

### Answer by username_2 on 2020-10-08. Score: 1

A firm has a business plan. From its perspective, resources are allocated “correctly” if they achieve its business plan. However, it is entirely possible that the business plan makes no sense, e.g., it is supplying a product far in excess of what customers are willing to buy. For public companies, equity market analysts attempt to project the effectiveness of those business plans. The volatility of equity prices is an indication that this is not easy.

A single project is typically evaluated with discounted cash flow analysis. (Similar to this question answer: [government analysis)](https://economics.stackexchange.com/questions/40077/if-the-government-builds-a-bridge-how-do-we-know-its-the-best-possible-usage-o) This gives us a project-level profitability measure, but we really need to evaluate the global business plan.

The issue is that “profitability” is somewhat vague: on what horizon? It is entirely possible for a firm to invest in projects to build capacity but those initial projects have very low profits (or even losses) during its growth years. However, the hope is that the firm is very profitable when it has reached its target size. Unless we wait, we cannot be sure whether this strategy will generate future profits or not.

> **Comments:**
> **username_0**: Hey, thanks username_2. I clarified my description above to make it cleaner. Can you edit your answer to more directly take on part 2 of my question? Sorry if it was unclear originally.  
> **username_2**: This question is marked as answered, which I am not sure about. However my answer to part 1 is that in the real world, we cannot really measure whether resource use is efficient without looking at the business plan. Amazon was famously unprofitable for a long time - were they inefficient? As such, your second question does not apply. If you want to ask this question, you really need to narrow it down. As the comments noted, it’s basically a good portion of microeconomics.  
> **username_0**: How is my 2nd question too broad? Somebody literally asked a question yesterday called: "How Are Expected Costs and Benefits Distinct from Ethical and Moral Judgments?" -- And got multiple answers. It doesn't logically make sense to entertain that question, but not entertain mine. I just want somebody to humor me & take a stab at my question... if somebody really understood the topic well, they'd be able to give me a succinct answer...  
> **username_0**: Also thanks username_2 for the nice, calm comment above. I'm honestly trying my hardest to ask the most precise + narrow questions possible (but still hard to answer :) ). But I feel like I'm getting my head ripped off for some reason :/  
> **username_2**: I don’t understand the hostility to this question. It is broad, but it seems that there would be at least a short explanation to point in the right direction. I have zero interest in microeconomics, so I can’t help you. Part of the issue might be that you asked a few questions with the same theme in short order.  

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