Profit: The Difference Between Two Variables
Profit or loss, then, is the difference between cost and selling price. It is usually impossible, however, to tell in advance of production what either the cost or the selling price will actually be; for the most careful calculations that can be made in advance are at best only estimates. Consequently, it is impossible to tell what the difference between these two variables will be, and whether it will be a plus or a minus quantity, a profit or a loss. This fact, though it may seem plain enough, is often overlooked, with the result that there is much confusion of thought concerning government regulation of profits, the obligation to earn no more than a 'fair profit,' the feasibility of conducting business at cost, and kindred matters.
It will pay us, therefore, to note carefully what this fact means to business. It means, in the first place, that a profit or loss is inevitable; since, according to the laws of probability, there is not one chance in many thousands that these two variables -- cost and selling price -- will turn out to be exactly even. In other words, there is virtually no possibility of conducting business exactly at cost, so that the outcome will be neither a surplus nor a deficit. For, if there is sufficient leeway between the two variables to make the covering of cost virtually certain, there is sufficient leeway to make almost as certain the realizing of a profit. So, also, if any business were conducted in such a way as to preclude the possibility of a profit, almost inevitably that business would suffer a loss.
In the second place, and for the same reason, there is no way whereby an enterprise can be carried on at a fixed rate of profit. To be sure, the Government can forbid an industry to retain more than six per cent of profit already earned, and can appropriate all earnings above that rate, as it does in the case of the Federal Reserve Banks; but it cannot establish conditions under which an industry is unable to earn more than six per cent without making virtually certain that it will earn less. No matter what rate we may call a 'fair profit,' therefore, it is impossible to conduct business at exactly that rate. Any plan of administration which guarantees that railroads, for example, or labor banks, or even electric light companies, will earn six per cent, virtually guarantees more than six per cent; and, except for the remote mathematical chances already mentioned, any plan which makes a profit of more than six per cent impossible makes a profit of six per cent impossible. The practical significance of all this is that few people would put money into a business unless there was a good chance of getting it back -of coming out even; but there cannot be a good chance of coming out even, unless there is a fair chance of coming out ahead.
Private Profits versus Community Gain
Private profits may or may not mean community gain. As a rule, they do. Mr. Ford, while accumulating vast individual profits, has provided the community with ten million automobiles and with valuable instruments of production. Both the cars and the capital are to some extent community gain. What Mr. Ford has done on a gigantic scale and with the applause of the people, hundreds of thousands of enterprisers have done on a small scale, though not always with popular approval. They have increased the productive resources of the country and thereby the possibilities of higher standards of living. No matter who owns all this new capital, it is in part a community gain.
On the other hand, individuals may realize profits without benefiting the community. In so far as they profit by buying and selling unimproved coal lands, by manipulating the stock market, by floating securities of useless corporations or by destroying needed enterprises, they make gains, but the community does not. Evidently we cannot tell what is sound public policy in matters of taxation and business regulation until we distinguish between those profit-making enterprises which add to community wealth and those which do not.
Prices versus Price-Levels
Throughout our discussion, we must take pains to keep in mind the distinction between individual prices and the general price-level. Otherwise we shall be in danger of confusion. By 'individual prices,' we mean the exchange value of any commodity or service -- say a ton of coal or a ride in a taxicab -- in terms of dollars. By 'the general price-level,' we mean a composite of all prices; that is to say, the cost of coal, taxicab rides, and everything else at one time or place, compared with the cost of the same commodities and services at another time or place.
The paramount interest of every community in the price-level is clear and indubitable: where the price-level happens to be is a matter of little consequence; the one thing needful is that it should stay about where it is. The interest of the community in individual prices -that is to say, in the relation of prices to each other on a given price-level -- is not so obvious.
The Forces of Supply and Demand
'Supply' is used throughout this volume to denote the quantity of commodities or services offered for exchange at a given time and place, and at a given price. 'Demand' indicates effective demand; that is to say, not merely desire, but desire accompanied by money or its equivalent; and demand, like supply, always refers to a given time, and place, and price.There are three fundamental tendencies: 1. When, at the prevailing price, demand exceeds supply, the price tends to rise and vice versa.
2. At a higher price there is likely to be a smaller demand and, sooner or later, a larger supply, and vice versa.
3. Price tends toward the level at which quantity demanded is equal to quantity supplied.
It is to these three tendencies that we shall refer whenever we speak of the forces of supply and demand. Various causes, under various conditions, offset these tendencies. With certain qualifications, the three forces apply, not solely to the prices of commodities, but also to the price paid for the use of capital, which we call 'interest'; and to wages and to all other remuneration for services.
So much for definitions. And now we trust that the adventurous reader who has persisted through these dull preliminaries, and still has the courage of his quest, will try to keep all this in mind, to the end that the path he is about to take, into one of the obscurest parts of 'the dismal science,' may be less dreary and difficult than otherwise it would surely be.