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.