Clarifiying What Profits Are

Every once in a while, I hear sentiments along the lines of: the United States is a society which ceaselessly chases and worships profits making, its time less of an emphasis is placed on profit making and more of an emphasis should be put on providing public goods. I cringe each time I hear that statement, especially from people who I expect to know more and not make such a careless statement.  Such sentiments show that many people really don’t fully grasp the role of profits in an economy.

There are two primary means of creating or amassing wealth. They are either through economic (entrepreneurial) means or political means. In the first, alert entrepreneurs looks out for ways to serve consumers in the best way possible. Entrepreneurs source for capital and the factors of production and bear the burden and risk of trying to serve consumers with the cheapest products possible. For example, a florist who invest $1000 uses the capital to source for the cheapest sources of flowers and other goods need to run the business  make sales of $5000 at the end of one month, which results in a profit of $4000. But on the other hand, a large corporation in a sector like steel spends $500,000 lobbying for preferential treatment and erection of barrier to entry and makes a $10 billion profit each quarter.

In the first instance the exchange is voluntary and no one is forced to patronize such a business, the business survives based on its quality of service and ability to serve consumers. Further, the profit of $4000 in a month sends out a signal that being a florist is lucrative and as a result other entrepreneurs move into the industry and resources are shifted towards serving that industry.  In the long run, as more people enter that line of production and output becomes greater, the prices which consumers pay decrease while profit margins drop.   But in the second instance, the transaction is not voluntary. Either through some kind of direct subsidy which comes from tax payers or restrictions into that field which restrict the number of producer possible, consumers involuntarily pick up the tab. Furthermore, resources which otherwise might more urgently be used in other areas of the economy are trapped such areas and not deployed to their optimum capacity.

In essence, profits are a mechanism which help in guiding entrepreneurial decision making and the steering of  very scarce resources around in an economy into the areas where they can most urgently be put to optimal use by the most capable hands. It is from profits that businesses are able to accumulate capital which is reinvested in such businesses and helps in making them become more efficient which leads consumers being served better and workers earning better wages. In societies in which no profit mechanisms of any kind exist, resources are wasted on massive scale and economic and social stagnation sets in with a poor standard of living. Such was the case of the USSR and many eastern bloc countries during the cold war decades (see Socialist Calculation Problem). The kind of profit making which should be curbed as much as possible and ultimately eliminated are those who are derived from political arrangements. Profits which derive from political arrangements are ultimately zero sum as they put resources to least efficient use and impoverish the general community.