I know this may seem like a simple question, but talking to so many people they seem to think that profit is a completely dishonest and immoral thing. I don’t understand it. To me, profit is compensation for your work (on a worker by worker basis, not looking at a company where it can mean something else entirely).
But maybe my definition is wrong. In reading the Wealth of Nations, Adam Smith calls it something above and beyond compensation, and with that definition profit almost seems like extortion.
So what would be the Austrian definition of profit?
Read “Profit & Loss” by Mises. It will clear everything up for you.
Profit is reward to the entrepreneur for risking his capital / savings for acting in a way which best services the public demand. If his offering to the economy were too expensive or not desired (not considered reasonable) by the economy then he would have no customers and would therefore suffer a loss. Profit is therefore a measure of success. The employee does not profit the same, but has no risk either. The employee in a new startup company / new venture (where there aren’t yet any revenues to pay the bills) gets paid a salary by the entrepreneur/investor, while the investor sacrifices, risks and foregoes personal consumption of his savings - to get paid later if and only if the enterprise turns out successful.
The wealth we have is accumulated by the work that we do and not above that. If there is profit, then doesn’t that mean that some of our work must go to profit and that some people must necessarily be undercompensated?
Sorry if I sound like I’m contesting Austrian economics. I only started getting into it a few months ago and I still have a great understanding of economics.
I think the first thing that you need to understand is that ALL valuations are subjective and different for every individual. For instance, you may value a $10,000 “profit” differently than would Donal Trump. Furthermore, you may value the trade off of your labor to earn $10,000 “profit” differently too. So, to understand profit, you have to accept that every single person will value the same actions and remunerations differently.
Profit is simply the difference between costs and returns. However, the next question is: “What units of measurement should we use fo those calculations?” Well, we could use dollars or some other currency. However, not all costs can be valued in an accounting sense. To illustrate, if you work yourself to the point where you get a stroke, go on disability and cash in a $100,000,000.00 disability payout, you may think you have profitted. Some one else may think the money is not worth the loss of good health. What constitutes “profit” is variable.
So, in simple terms, true profit is whatever you want it to be. That is probably not the answer you are were expecting.
You know, I think that’s what I was thinking profit to be. So then according to that definition, price gouging as a term makes no sense, if I’m reading into this correctly.
Profit is the reward for allocating resources to the position most demanded by consumers.
Profit and Loss together signal entrepreneurs how to allocate resources.
To pay workers for the profit that a company makes means you would also have to charge them for the losses that a company is working under. Over time profits tend to approach zero as more entrepreneneurs enter that field and bid up wages in order to attract more workers.
this isnt strictly true, but if you imagine workers sharing the profits of the company, it does invite a mystery as to why a capitalist would employ workers in his enterprise at all if he gets no profit (or much lesser) to incentivise him to do so.
Correct, price gouging is a slur. It is where price rises to meet increased demand - while providing the signal to entrepreneurs to provide more product to meet higher demand.
Say there’s a heat wave in May and everyone runs out to buy an AC unit. Huge demand for AC. If prices do not rise then all the units will be gone on the first day. You are willing to pay more money for an AC unit but there is none to be found. If the prices were permitted to rise with demand then those who demand the AC the most are willing to pay the higher price. As in an ebay auction, those who are willing to pay the higher price get the goods. Also, because prices are high due to increased demand the businesses see large profitability in AC units. Therefore, businesses hurry to import as many new AC units as possible to turn a higher profit. The businesses will flood the market with AC units until everyone who wants one gets one, and prices fall back to normal supply/demand again. If prices were not allowed to rise then businesses would not detect the high demand for AC units and would not rush to get more on their shelves. This would create a shortage of AC units.
True, you wouldn’t necessarily have to charge for losses and I’ve certainly never gotten a negative bonus, but if it is “fair” to pay workers for any profits then why is it not “fair” to charge them for losses? It’s simple rebuttal of the “profits are exploitive” garbage.
First I’m just dabbling into AE, it’s just one of my many interests, so don’t take my answer too seriously, but profit isn’t payment for work. Profit is arbitrage.
The guy who manages his own business wears 3 and thus pays himself for 3 different things:
interest on capital, which in a small family business isn’t much, which is the price of time, of deferred consumption
managerial salary for his managerial work, same amount he had to pay to an employee-manager: probably for a small business this consists of the majority of it
arbitrage. This is the real definition of profit, because this is what entrepreneurship is about, however in a small business it is small, interest on capital is small too, in a small business it’s the managerial salary that’s most of it.
There are many kinds of arbitrage. Simplest is geographical, i.e. trade. Buy coffee cheap in Columbia, sell it at a profit in the UK. Reason is supply is high in Columbia, low in the UK, demand can be considered largely similar. If more and more people jump into this business, arbitrage goes down to close to zero, as prices will go up in Columbia and low in the UK. Arbitrage, entrepreneurship is all about recognizing a difference in prices which means a difference in supply and demand at different places. It cannot last forever, competition will erode it to close to zero as other entrepreneurs jump in.
Arbitrage is socially useful, because it equalizes in the long run supply, demand, and thus prices: reduces oversupply and reduces overdemand i.e. scarcity i.e. want.
There are other kinds of arbitrage. Arbitrage in time: speculation, similarly socially useful. Arbitrage in knowledge, like with innovation and new products. And so on.
They all work as great equalizers.
It’s a great irony, that egalitarians, those who believe equality is an important ethical goal should praise entrepreneurs: they make big money, sure, but they help a lot to make f.e. Columbian and UK citizen have largely equal supplies and demands for coffee and largely equal prices, they should praise them…
I would say that profit is the reward that society pays you for your work.
If you buy a failing company and liquidate it for a profit, then you have been paid for the value of transforming a failing company into resources for several more successful ones, which in turn provide more value to society.
If you charge gas money for someone you give a ride to, the value of that money (minus the cost of the gas used for the ride plus wear and tear) is the reward you get for satisfying that person’s need to be somewhere else.