Where do Profits come from?

Economics: Lesson 135

How can profit arise in a free market economy if every factor of production is paid what it is worth to customers?

The Free market competition pays all factors of production what the customers determine. The customers are in authority because they have the money. So if everything is paid what it is worth, how do you make a profit? The answer is ignorance.

Entrepreneurs, factor owners, even customers are not omniscient. No one knows what is going to happen in the future, therefore they cannot predict what things will cost in the future. An entrepreneur who sees an opportunity thinks that opportunity will turn a profit. They buy up factors of production at low prices and combine them to make consumer goods, then the final price of the goods is going to be whatever customers will pay. But what if the entrepreneur is mistaken? What if the good he makes is a flop, or the factors of production cost too much and the final price of the goods could not cover it? He makes a loss. But, what if he makes a profit? Those profits will send signals to competitors and resource owners that there is money to be made, and they will all flock to that section of the market.

“Thus, profit and loss are generated by success or failure in adjusting the course of production activities to the most urgent demand of the consumers…Profit and loss are ever-present features only on account of the fact that ceaseless change in the economic data makes again and again new discrepancies, and consequently the need for new adjustments originates.” (Ludwig von Mises, Profit and Loss)

In conclusion, profits and losses cannot be predicted, and they result from decisions from entrepreneurs and factor owners that were made in ignorance.

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