On profit


December 21, 2011 by galudwig

A comment by Michael Wilson on my post on inequality claimed that there are plenty of ways to accumulate extreme wealth without contributing to society. While this is entirely true for our current economic system, which is a mixed, middle-of-the-road policy between socialism and a free market, this cannot be true in the case of a free society with an unhampered market.

Because I know that this statement – that, in a free market, profit can be made only by making a contribution to society – will be rejected by most, I want to explain a little bit more clearly what I mean. These are my assumptions about the kind of society where this would be true:

  • individuals are free to associate and exchange with one another any way they see fit
  • all exchanges are made voluntarily
  • no government or other extra-market institution exists which coerces individuals or impedes their behaviour in any way whatsoever
  • private property is protected and enforced, either by a non-coercive limited “government”, or by security or insurance firms

Under these assumptions, a producer of goods or services, owner of capital, speculator, artist or any other possible agent on the free market, can only increase their wealth by serving the needs of the consumers in society.

Every actor on an unhampered market is simultaneously a producer and consumer. The producer of goods and services engages in entrepreneurial activity in the sense that he or she must attempt to anticipate correctly the future demands of the consumers and the effect this will have on the future state of the market. As long as people are not entirely satisfied with their conditions, and the preferences of consumers, as well as all other factors, keep changing, there will always be discrepancies in the current structure of production.

Profit emerges in the present when an entrepreneur’s anticipations of the future state of the market, and the actions he or she undertook taking into accordance these anticipations, turned out to be correct in retrospect. Ludwig von Mises in Planning for Freedom:

What makes profit emerge is the fact that the entrepreneur who judges the future prices of the products more correctly than other people do buys some or all of the factors of production at prices which, seen from the point of view of the future state of the market, are too low. Thus the total costs of production –including interest on the capital invested– lag behind the prices which the entrepreneur receives for the product. This difference is entrepreneurial profit.

Thus profit is generated by success in adjusting the course of production activities to the most urgent demand of the consumers. Once this adjustment is achieved, it disappears. The prices of the complementary factors of production reach a height at which total costs of production coincide with the price of the product. Profit and loss are ever-present features only on account of the fact that ceaseless change in the economic data makes again and again new discrepancies, and consequently the need for new adjustments originate.

By buying and refusing to buy certain products on the market, consumers choose to reward those producers who best serve their needs. In this way, the system of profit and loss drives the continual improvement of the market, constantly adjusting the structure of production to the preferences of consumers, by weeding out the unsuccessful and rewarding the good entrepreneurs by awarding them more means at their disposal. To put it in the words of Ludwig von Mises again,

The consumers by their buying and abstention from buying elect the entrepreneurs in a daily repeated plebiscite as it were. They determine who should own and who not, and how much each owner should own.

My time to continue writing this is running short. Maybe I’ll write more later. But my point is clear. Profits are made by owners of capital by successsfully adjusting the structure of production according to consumer needs.


5 thoughts on “On profit

  1. In an ideal world where consumers were informed, all nations played fairly, big corporations never dumped product or abused patents to drive out competition and salesmen never manipulated naive customers into making unwanted purchases, a totally free market would be fantastic!

    But the real world has never been that way and probably never will be – as they say “money is the root of all evil”. I think the best we can do is create a system with minimal, intelligent rules and regulations – then let the free market do the rest.

    P.S. Who’s Michael Lewis? ;^)

    • galudwig says:

      LOL sorry I used to know a Michael Lewis, force of habit, changed it

      Actually, I would take exactly the opposite stance. In a world where people were rational consumers who knew exactly what they wanted and where nations could predict this behaviour and plan correctly for the multitude of humans in society, a planned economy would work perfectly! I support the free market because knowledge is dispersed, because regulatory institutions are inevitably captured, because coercion has no place in civilised society and because cooperation between individuals leads to a spontaneous order, much superior to that which any single mind or select group of mind can come up with. I would agree with you that minimal, intelligent rules and regulations would be a good thing, IF the result would be better than what a market could produce. In my opinion this is just not the case.

      Oh and for the record, I dislike patents, fraud, deception and pro-business legislation as well. And in the case of pollution, I think the free market has a much better solution for environmental problems than any monopoly or pseudo-market based ones. It’s just that it requires a radical rethinking of society and state..

  2. I guess we’re both libertarians, just different degrees. I spent some time in East Germany and agree that planned economies don’t work well.

    You mention your belief in protecting property rights, but you dislike patents. How would intellectual property rights be protected without patents?

    • galudwig says:

      I was a firm believer in limited government and “moderate” libertarianism myself until I began reading the likes of Mises and Rothbard. I wrestled with it all through college but now fully embrace what probably would be called an extreme, unworkable position by even committed libertarians.. Combine this with living in Europe and you’ve got yourself an intellectually very lonely guy 😀
      I truly believe there is no valid reason whatsoever for any degree of planning, however small in scope, at all because it can only make the outcome worse than what it would have been under a free market, unless the planner is assumed to be a benevolent, omniscient and omnipotent angel 🙂

      Well, patent theory is something which is extremely divisive for libertarians. I actually try to keep clear of it as much as possible because it’s so complex and I feel there are much more important debates going on today. But, in short I think we should rethink what “intellectual property” really means. Any patent is a temporary monopoly, enforced by the government, on an idea, in other words a “recipe for creating something”. How can anyone really own a thing like that? In the same vein, I think there should be no laws against slander or libel because no one can hold a monopoly on intangible things which exists in one’s or other peoples’ minds.
      This is probably not the best place to be having an in-depth debate on the matter, but if you’re interested in it, I think the following essay by Stephan Kinsella gives a great overview of IP and the different libertarians answers to it, and specifically the anti-IP argument:

      Anyway, I’ll stop talking now. Merry Christmas!

  3. Not to mention that there has never been a government willing to limit itself to providing only a “system with minimal, intelligent rules and regulations.” The United States was supposed to be something like that but now we’ve got an empire, a federal registrar that is over 100,000 pages long, and tens of trillions of dollars in debt.

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