The Source of Profits

on Wednesday, September 28, 2011

"Haeuser mit bunter Wasche" Sold for $40 million.
I think Mises is dead wrong about the source of “entrepreneurial profit.” He claims:

“A man earns profits only if he has, by superior foresight and judgment, uncovered a maladjustment—specifically an undervaluation of certain factors [of production] by the market.”

If I purchase a canvas, paint brushes, and oil paints, and labor to organize those paints on the canvas in so doing create a beautiful work of art that is auctioned at Sotheby’s for $1 million, did I earn a profit because I determined that the capital goods, the factors of production (paint, brushes, canvas) were undervalued?

No, I earned a profit by creating wealth; by organizing/changing the world around me into something more valuable. That is one source of profits earned by entrepreneurs.

The other source of profit is in trade. Each trade, if voluntary, makes both parties to the trade richer, according to his own assessment, he is better off. The item he receives is worth more than the item he trades away; and he has therefore made a profit.

The investment in capital equipment is not arbitrage, as Mises claims. The investment is either a voluntary trade, or the beginning of a creative (organizing) process. Does anyone imagine that Steve Jobs is wealthy because he identified undervalued computer chips and aluminum ore? No, Jobs creates wealth in the same way that a painter does — by organizing the world into something more valuable than its unassembled parts.

Profits are generated when an entrepreneur changes and organizes the world into something more valuable, and losses are generated when he changes the world into something that people value less than they did before. If he buys a forest for $10 million, harvests the trees and builds homes where they used to be, but is able to sell the homes for $5 million, his loss is endured only because he reduced the value of the forest in the eyes of the world.

Profits are generated when wealth is created, and losses occur when wealth is destroyed.