The Importance of Profits

For many people, the word "profit" evokes visions of rich robber barons, and greedy tycoons colluding to steal wealth from everyone else.  It's a word that is even synonymous with "greed" in a lot of minds.  Profit - according to some - is merely a "motive", propelling villains to choose the shady acquisition of money over the welfare of other people.

But is this really true?

Sure, dreams of being successful motivate everyone to one degree or another...  No one starts a business to lose money!

But profits are so much more than simply a reason for people to start a business.   There are plenty of reasons to do that...

Profits are actually an extremely important feedback mechanism which helps producers determine whether or not they are making & selling things people want at prices they're willing to pay. This information enables investors & business-owners to make complex market decisions... Decisions that could never be made without knowledge provided by observing profits & losses.

As economist Steve Horwitz wrote:^[1]

"What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not."

How do producers decide to build houses instead of office buildings, cargo ships  or cruise ships?  How do they know if their business is providing customers with what they want or if they are wasting their time producing something no one likes or offering services no one needs?^[2]

Profits & losses provide producers with knowledge of their success or failure - as judged by their own consumers.^[3]

Likewise, prices provide us with information on what people value.  A product that commands a higher price means that there is more demand for the product than there is supply available.  Information provided by free prices has another benefit... It helps both producers and consumers make decisions about how to use their limited resources.  For producers, high prices encourage increased production - for consumers, high prices encourage limited consumption.^[4]

This way, the supply of goods and the demand for them are always moving towards each other. Where supply & demand meet is what economists call "equilibrium".

However, the story doesn't end there.

Where all this gets confusing is that many corporations find free market competition to be too difficult.  Instead, some businesses prefer to obtain profits without actually offering consumers something of value.  They accomplish this by lobbying their friends in government for special favors - such as subsidies, tax exemptions, or other protection from competitors.^[5]

Unfortunately, government has the power to take money by force from their citizens, so when laws are written which redirect money to favored companies, the government is also destroying the valuable information that profits & losses provide.  Thus government involvement has the power to radically distort market signals^[6] and artificially promote the misallocation of resources.^[7]

Profits & losses generated in a free market are crucially important and provide the information all of us need to make sound economic decisions every day.

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Works Cited: 

1. Horwitz, Steven G. "Profits: Not Just a Motive." The Freeman 58.2 (2008), pp. 21-23. The Freeman Online. Mar. 2008. Web. 28 Feb. 2010.  http://www.thefreemanonline.org/featured/profit-not-just-a-motive/
2. Hayek, Friedrich A. "The Use of Knowledge in Society." 1945. Library of Economics and Liberty. Retrieved March 1, 2010 from the World Wide Web: http://www.econlib.org/library/Essays/hykKnw1.html
   
3. Hazlitt, Henry. Economics in one lesson. New York: Arlington House, 1979. Print. "The Function of Profits", pp. 144-147. (PDF)
4. "Price Signal." Wikipedia, the free encyclopedia. Web. 01 Mar. 2010. http://en.wikipedia.org/wiki/Price_signal
5. Stossel, John. "Big Government's Cronies." Reason Magazine. Reason Foundation, 4 Feb. 2010. Web. 28 Feb. 2010. http://reason.com/archives/2010/02/04/big-governments-cronies
6. Reisman, George. Capitalism: a treatise on economics. Ottawa, Ill: Jameson , Distributed by LPC Group, 1996. Print."Profits and the Repeal of Price Controls", pp. 180-183. (PDF).
7. Mises, Ludwig Von, Murray N. Rothbard, Gottfried Haberler, and Friedrich A. Hayek. The Austrian Theory of the Trade Cycle and Other Essays. Auburn: Ludwig Von Mises Inst, 1996. Print. (PDF)