Profits.—The return received by the organizers and managers of productive enterprises is commonly known as profit. The amount of their profit depends upon the degree of success with which they can produce goods for less than the selling price. Every employer or organizer assumes a considerable amount of risk. He obligates himself to pay definite amounts for the use of capital, materials, and labor no matter what the value of the finished products. If this value be less than the cost of production, he loses; if it be more, he gains. Losses, if continued, mean bankruptcy. Gains are profits and, if continued, make him rich. It will be seen, therefore, that the employers or organizers of production take more risk than those who supply the materials, the capital, or the labor. |What determines the rate of profits.| Their success, in other words their rate of profits, depends in general upon the degree of managing and organizing ability which they display; but it sometimes happens that profits will be high in all branches of production for a time irrespective of the employer’s skill. The price of the finished product may rise without an immediate and proportionate increase in the cost of materials, interest, and wages. This situation, while it continues, affords an opportunity for abnormal profits or “profiteering” as it is often called. Abnormal profits may also be due to the existence of a monopoly in a particular form of production.
The economic importance of government.
Government as a Factor in Production.—It has not been customary to speak of government as one of the essential factors in production, but a few moments’ reflection will show that its part in the process of industry and trade is very important. To begin with, the government determines what forms of production may be carried on and by what methods. It forbids certain forms, such as the making of intoxicants, and strictly limits others, such as the manufacture of narcotics. It gives to some individuals and corporations the exclusive right to produce certain articles under patents. It determines the forms of business organizations, the responsibilities of employers, the rules relating to partnership, and the powers of corporations. It sets a limit upon the rate of interest by means of usury laws and through its banks may virtually control the rate (see p. [438]). The government, moreover, makes rules for the conservation of natural resources and to some extent fixes the relation between the employer and his workers. At times it even fixes prices. It provides courts and commissions for the settlement of disputes affecting production. Finally, the whole system of private property rests upon the support of the government.
Taxes as an element in cost.
What return does the government get for these services to production? Offhand, one might say that the government receives its return in taxes. In a sense this is true, for taxes, like interest, wages, and profits, must be paid from the selling price of goods. Taxes, indeed, must be provided for before profits can be determined. But it is not usual, nor is it accurate, to speak of taxes as a reward or return for services which the government renders. Revenue in the form of taxation is essential in order that a government may function properly, yet there is no close relation between the rate of taxation and the amount of service given. This whole question of taxation, in theory and in practice, will be discussed further on.
Some Essential Economic Activities
The way in which each factor in production obtains its share.
Exchange.—It has been shown that several factors in production are each entitled to their share. This share is reckoned in terms of money because every producer gets his own return in terms of money. In other words goods are exchanged for money, and money in turn is exchanged for other goods or service. This mechanism of exchange engages the energy of a great many individuals and institutions, such as wholesalers, retailers, brokers, and banks. Economic goods would have relatively little value if they could not be translated into money and thus distributed from hand to hand. No one, as a rule, can live and flourish by consuming exactly what he produces and nothing else. He must use his share in what he produces as purchasing-power to secure whatever best satisfies his own wants. Money is the lubricant which facilitates this; in a word, it is the medium of exchange.
Definition of value.
Value and Price.—Exchange takes place on a basis of relative values. He who sells goods or services receives something of assumed equal value in return. But what is value? The term value is employed in two different senses, value in use and value in exchange. By the former we mean the intrinsic utility of a thing. Air and sunlight, for example, have a high value in use; they are indispensable to life in fact; but they have no value in exchange. When the economist speaks of value he means value in exchange or market value, that is to say the ratio in which one commodity or service will exchange for other commodities. If a ton of coal can be exchanged for a large quantity of cloth, or food, or labor, its value is high; if it can be exchanged for only small amounts of these other commodities, its value is said to be low.