Various Kinds of Income
What are these economic problems that center around profits? Obviously, they are concerned with the relative incomes of capital and labor. Less obviously, but not less vitally, they are concerned with the influence of profits and their distribution on the circulation of money, on the balance of supply and demand, and on unemployment. Rather obscurely, but essentially, as we shall see, they have to do with the possibility, in any other than a price and profit economy, of preserving consumers' freedom of choice and eliminating the unfit among business enterprisers. In general, all these problems deal with the different effects upon material wealth and human welfare of various methods of making and disbursing profits.
Clearly, then, we are about to grapple with some of the real issues in current political upheavals and industrial experiments. So absorbing are all these questions that we are loath to delay our discussion long enough to define its terms. But we shall save time if we make sure that we understand what we mean by money and income, wages and profits, wealth and capital, prices and the price-level, supply and demand. The fact that these are terms of everyday speech should make us all the more wary about using them vaguely. They are beset with economic pitfalls.
Economics
Economics is the science that deals with human interests from the standpoint of price. This definition covers not only the production and distribution of commodities and services, but all other human' interests, in so far as they are measured in terms of money. The fundamental characteristic of every science is a close approximation to exact measurements. Each science is known by its point of viewand its consequent units of measurement. Mechanics measures an engine in terms of horse power, and dietetics measures an egg in terms of calories; while economics measures both engines and eggs in terms of dollars. Without such a measure, there would be no science. For this reason, we consider money the central and unifying feature of the science of economics.
Money
By 'money' economists sometimes mean anything that is (1) passed from hand to hand throughout a community in payment for commodities and services, and (2) regularly taken with the intention of offering it in payment to others, and (3) customarily received without assay or other special test of quality or quantity, and (4) received without reference to or reliance upon the personal credit of the one who offers it. To cover all this, we shall use the term 'currency.'
The term 'money' we shall use throughout our discussion, in accordance with the everyday practice of business men, to cover not only all forms of currency, but bank credit as well. By 'bank credit' we mean deposits transferable by check. It is important to bear in mind that 'money' always means 'circulating purchasing power' and always includes both currency and bank credit.
Goods
As profits are derived from the production and exchange of goods, we shall make frequent use of that term. By 'goods,' we mean not only tangible goods, such as cotton and engines, for which we use the term 'commodities,' but also intangible goods, such as light and power; and a third source of human satisfactions, such as the work of teachers, bankers, and motormen, which we call 'services.' Economic goods, then, consist of commodities, both tangible and intangible, and services.
Money versus Wealth
In two opposite ways, money has been a source of confusion to economic thought. First, men attached to money a kind of importance which it did not possess. They regarded money as a kind of national wealth which, like any other kind of wealth, increased in value as its quantity increased. Later, after the fallacy of this first position had been exposed, money came to be regarded as relatively insignificant. Thus, at first because its importance was overestimated, and later because its importance was underestimated, money has been a stumbling block in the way of an understanding of economic processes and results.
It is important to keep in mind the distinction between money and other forms of wealth. From the standpoint of an individual, money is regarded as wealth, for it is a command over the objects of wealth. The more money an individual has, the better off he is, economically. It is not true, however, that the more money a nation has, the better off it is. The material wealth of a nation -- the 'real wealth' -- is its wheat, factories, railroads, mines, forests.
In our study of profits, this distinction between money and other forms of wealth is important. It makes a vast difference, and one that is sometimes perceived too late, whether profits are in dollars or in leather.
Income
There are four agents of production: land, capital, labor, and organization. The income of these four agents is received in the form of rent, interest, wages, and profits. Ordinarily, rent, interest, wages, and profits are all paid in money. Outside the domain of commerce, it is true, the income of many persons -- farmers, teachers, and household servants, for example -- consists in part of things other than money. Net business income, however, is the amount of money accrued less the amount of money charged to expenses; and it is mainly with net business income that we shall be concerned. By the term 'income,' therefore, unless otherwise stated, we mean money income.
Whether we are considering money as a whole, or wages, or profits, it is the circulation and not the reservoir that is most significant. This points to an important difference between income and capital. Income, as the name implies, is a flow; capital is a fund. Accordingly, we always speak of the income of a given period of time, but of the capital existing at a given instant of time. Thus, the annual report of a corporation gives the capital account as of December 31, but the income account of twelve months.
Real Income versus Money Income
A man's real income consists of goods. The scales show how many pounds of beef he brings home for dinner, but he does not eat the scales; and this relation between scales and a real meal is precisely the relation between dollar income and real income. Money is a measure of his real income. This week it may comprise three quarts of milk, police protection, a daily newspaper, and so forth, to the end of a long list of commodities and services. But if you asked him the size of his income, he would not proceed to enumerate these real items. He would sum it all tip by saying, 'Fifty dollars a week,' because he habitually measures income and all other strictly economic matters in terms of money.
Nevertheless, real income, not money income, is the economic source of his satisfactions; and this source can be increased or decreased by changes in his pay envelope only in so far as these changes modify his effective demand in the markets, that is to say, his command over goods. In other words, it is the bread, hats, tires, medical care, entertainment, and the like, that he buys with his wages, and not the dollars, that constitute his 'real wages.' Accordingly, when we speak of a man's 'wages,' we mean money wages; but when we refer to the goods that his money wages will buy, we use the term real wages.' It is important, though sometimes difficult, to keep this distinction in mind.
The money income of a nation is the sum total of all the individual money incomes. That sum total can be increased very easily. Germany had no difficulty in making a trillion marks grow where one grew before; but not a trillion blades of grass. While the printing-presses made millionaires of everybody, the mines and farms and factories did not keep up the pace. The money income of the nation rose while the real income fell. Regardless of what happens to rent, interest, wages, and profits, the total real income of a nation in any year is the total of commodities and services produced or received during that year.
Profits
From the gross income of any business, all the expenses must be paid, including rent of land, buildings, machines, and so forth, interest on money, wages of labor, and wages of management. The money income that is left over, if any, is profits, or pure profits. This is the only sense in which we shall use the term 'profits.'
Sometimes, the term gross profits or ordinary profits is used to cover all income that is disbursed as interest, rent, and wages of management, together with all that is left over. Sometimes the term business profits is used to cover wages of management and pure profits.
Obviously, no business could long continue without sufficient income to pay rent, interest, and wages of management. For this reason, the amount necessary to cover these three items is sometimes called minimum profits. The uses of all these terms are shown in the diagram.
It is only recently that profits have been clearly segregated, as in our use of the term, from interest and from wages of management, and studied as a distinct problem. That problem arose out of the development of the modern corporation, with its hired executives, as the dominant form of business enterprise. Formerly the typical concern was one in which the manager furnished the capital; and little attempt was made to distinguish between his reward as a capitalist and his reward as a manager. Nowadays, the typical enterprise is the corporation with its paid executives and borrowed capital. And even where the managers are the sole or chief owners of the capital, income taxes have brought about a sharp differentiation between their rewards as executives and their rewards as shareholders.
Wages are unlike profits in this important respect: wages are paid in advance, whether any profits are realized or not, whereas profits are paid only after they are realized. All business costs, including wages, are advances made in the expectation that selling prices will yield profits. Frequently, as we shall see, that expectation is not well founded.
 More Readings |
