I’m not getting why profits and losses are a temporary phenomena as Mises is saying in Human Action, chapter XV, in the section: Entrepreneurial Profits and Losses in a Progressing Economy, page 295, 3rd paragraph.
An entrepreneur makes a long term investment in property and plant, and machinery, and hires full time employees. He is planning for long term operation. If the best he can hope for is temporary profits, wouldn’t he go out of business in short order?
A question I think I can answer… but, correct me if I’m off base somewhere. I’m on Week 13 of the self-study course.
So far my understanding is that when an action is profitable, more and more entrepreneurs will move into that area until competition drives the price down until all that remains is the interest return on investment.
The same will happen with losses, but instead it will reverse itself. Entrepreneurs will move away from loss generating activities until the surviving producers are merely earning an interest return.
Keep in mind that “temporary” could be any range of time. For example, Apple’s ipod may be profitable for many years until Microsoft, and Creative, and Sansa, etc. drive the price down. A good business, however, will keep improving their products so they remain profitable. Apple offers larger ipods, ipods that have video, ipods that play games, and ipods that make phone calls in order to remain profitable in that line of business.
Can you paste the paragraph here, please? I don’t find anything like what you say in pg 295, 3rd para.
Mainly because conditions of his action are always changing - consumer tastes(demand) do change over time, competitors improve their products, new competitors enter the market (supply), also prices and availability of entrepreneurs’ inputs (raw materials, machines, labor etc.) change too. The whole idea is that he constantly needs to adjust his actions to changes in a market other wise he WILL go out of business. In other words there is no good plan that would suffice forever it need to be constantly readjusted to ever changing conditions. One who fails to adjust on time will fail in favor those who did better in reading market’s (people’s) demand.
hope this helped
Profits/losses are the “products” of uncertainty arising from a mismatch between supply and demand (and are consequently phenomena pertaining to market disequilibria; basically profits arise when demand for a product is high and unmet, usually with the introduction of a new product.) Markets tend towards equilibrium because entrepreneurs, alerting themselves to the potential for profit that the existing entrepreneur is reaping, will enter the market, extending supply and diminishing prices, pushing profit levels down. Losses will impel them to avoid the industry, and existing entepreneurs will try exit the market ASAP if no improvement is in sight. Keep in mind costs are opportunity costs, i.e. other lines of production various factors can be engaged in - entrepreneurs will strive to divert them to the most profitable course available (harder with specific than non-specific factors.)
Returns on capital are separate, and amount to the MVP of the machines &c. involved.
Suppose your business is ridiculously profitable and you’re earning 50% annual returns. Soon, you’ll be faced with competition and your profits will return to reasonable levels.
Suppose your business is losing money or earning subpar returns. You or some of your competitors will go broke. Then, profits rise for the remaining market participants.
There will always be profits for a reasonably run business. You shouldn’t expect to get super-awesome returns for an extended period of time without facing competition.
The above arbitrage process only occurs in a really free market.
In the present, government restriction of the market prevents this arbitrage from occurring. For example, FRE and FNM have a very profitable business. Their debt is backed by the Federal government, lowering their borrowing costs. I can’t start a mortgage financing business that competes with FRE and FNM, because I don’t have the “debt backed by Federal government” perk that they get.
As another example, Goldman Sachs earns huge returns. I couldn’t match those returns without bribing/purchasing a bunch of Congressmen.
That is actually very important point in context of emerging new branch of economics namely Complexity Economics. Markets actually are never in equilibrium, and it’s not because they fail or are not efficient but because the economy is complex and dynamic(!) system. So what actually makes system working is profit seeking incentive that drives capital-owners and entrepreneurs to fill the gaps between supply of higher order goods and demand for lower order goods. What is more interesting that those that fail go bankrupt and their actions are avoided in the future and actions of those who succeed are copied - so we have an example selection and amplification of evolutionary algorithm working in economic field. I like to think about it in terms of animals that look different food sources for survival - those that fail - die(selection), those that succeed can procreate (amplify) - it is a major simplification but I think you get the point. It is yet another prove that Austrian economists were way ahead of their times.
Because profit and loss are disequilibrium phenomena and the market tends towards equilibrium.
I have Human Action as a PDF file that I downloaded from the internet, and I’m not able to copy and paste. I will type it in by hand. This is from Human Action Chapter XV The Market, section 9 Entrepreneurial Profits and Losses in a Progressing Economy, pg 295, paragraph 3. These are the words of Ludwig Von Mises:
First of all we must realize that entrepreneurial profits are not a lasting phenomenon but only temporary. There prevails an inherent tendency for profits and losses to disappear. The market is always moving toward the emergence of the final prices and the final state of rest. If new changes in the data were not to interrupt this movement and not to create the need for a new adjustment of production to the altered conditions, the prices of all complementary factors of production would - due allowance being made for time preference - finally equal the price of the product, and nothing would be left for profit or losses. In the long run every increase of productivity benefits exclusively the workers and some groups of the owners of land and of capital goods.
Hey man,
I think I’m pick-en up what you’re lay-en down. Maybe what Von Mises meant was that the profit, based on everything the company has done to earn them, up to the present time, will not last. I wish he would have spelled that out a little more precisely if that is, in fact, what he meant. Thanks for helping me with this.
Not temporary would be permanent?
I’m kinda amateur at economics, but let me try to put some Hayekian spin on this. As others have said, profits come from a mismatch of supply and demand. Demand exceeds supply, so the goods must be rationed-which occurs through prices in a free market. The market is sending a signal that there is inadequate supply, so the profits supply the capital with which to fund this expansion of goods. These profits at the same time attract other economic agents to produce the desired product, which also penalizes firms that squander too much of this capital on themselves(by competitors stealing customers). The reason why these profits can’t be permanent, is that eventually(assuming nothing changes) supply will catch up to demand. At that point, any further expansion of supply will only divert resources from the production of more desired goods, and profits will disappear and signal an end to expansion.
In short, permanent profits would signal both indefinate expansion of the supply of goods, and infinite reduction in the cost of production(approaching zero). That does not sound like an efficient market to me.
Appreciate your effort!
I have tried explaining profits using easy metaphors here in my article.
Profits and losses are basically an allocative phenomenon. My article basically deals with what this ‘disequilibrium’ in allocation is, that brings about profits and losses. Once you understand it, you’ll understand that profits are temporary because the disequilibrium is continuously being corrected by entrepreneurs searching for profits, and avoiding losses.