The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.
This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.
Profit is the difference between the cost of production (including materials, wages, distribution and overhead) and the price at which the product can be sold at.
Profit is a dirty word according to many people today. This is because they don’t understand it. When Barack Obama said “I think there’s a point when you’ve made enough profit”, he showed his lack of understanding of the vital function profits play in our economy. Hazlitt invited his readers to review Chapter 14 on the price system, but to know he would be looking at it from a different angle.
Profits actually do not bulk large in our total economy. The net income of incorporated business in the fifteen years from 1929 to 1943, to take an illustrative figure, averaged less than 5 percent of the total national income. Yet “profits” are the form of income toward
which there is most hostility.
The average business in America makes about a 6% profit margin in 2016. Consider that we have the word “profiteer” to stigmatize those who make allegedly excessive profits, but there is no such word as “wageer”—or “losseer.” The profits of the owner of a barber shop may average much less than the salary of a movie star or the head of a Wall Street bank, but often they make less even than the average wage for skilled labor.
Hazlitt used a lot of examples from his own era that mean nothing to us today, but he pointed out that most entrepreneurs do not succeed in becoming rich, mainly because they tend to be too optimistic about their ability to succeed in business.
It is clear … that any individual placing venture capital runs a risk not only of earning no return but of losing his whole principal.
Governmental policy almost everywhere today tends to assume that production will go on automatically, regardless of what is done to discourage it. In Hazlitt’s day government price-fixing policies were a real concern.
Not only do these policies put one item after another out of production by leaving no incentive to make it, but their long-run effect is to prevent a balance of production
in accordance with the actual demands of consumers.
If the economy were free, demand would caused some branches of production to make what government officials would regard as “excessive” or “unreasonable” profits. That would prompt every in that industry to expand its production to the utmost and reinvest its profits in more machinery and more employment. It would also attract new investors and producers from everywhere, until production in that line was great enough to meet
demand, and the profits in it again fell to the general average level.
In a free economy, in which wages, costs, and prices are left to be set by the interaction of the competitive market, the prospect of profits decides what articles will be made, and in what quantities—and what articles will not be made at all. If there is no profit in making an article, it is a sign that the labor and capital devoted to its production are misdirected.
Profits function to channel the factors of production so as to apportion the output of thousands of different commodities in accordance with demand. No bureaucrat, no matter how brilliant, can solve this problem arbitrarily. Free prices and free profits will maximize production and relieve shortages quicker than any other system. Arbitrarily-fixed prices and arbitrarily-limited profits can only prolong shortages and reduce production and
Profits also function to put constant pressure on the head of every competitive business to introduce further economies and efficiencies. In good times he does this to increase his
profits further. In ordinary times he does it to keep ahead of his competitors. In bad times, he does it to maximize his chance of survival.
For profits may not only go to zero; they may quickly turn into losses; and a man will put forth greater efforts to save himself from ruin than he will merely to improve his position.
Profits, which result from the relationships of costs to prices, tell us which goods it is most economical to make, but also which are the most economical ways to make them.
A socialist system must answer these questions too. Every economic system must. The capitalist system has proven incomparably superior than others at obtaining this information.