Is Profit Good or Bad?

When talking about markets the topic of profits invariably comes up. Some people see profits as a great thing that should be embraced, others see profits an an evil thing that should be avoided. Let's explore this very important topic!

by Quinton on October 3rd, 2016

What is a profit?

We hear this term all the time and we kind of have a cursory definition of what it means. But what really is it? A dictionary will tell us something like:

a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.

This is a fair definition, but it's a bit dry. When most people think profit they think money and they think business. This isn't really what it is. I mean it is, but it is more than that. There is so much hidden intelligence baked into the very concept of a profit.

A profit is basically getting more output than input. It's getting more out of something than you put in. A surplus essentially. But what does this mean? What does this infer?

Another way to state it is like: A profit is the positive difference between the total costs of production and the resulting price paid by the consumer. The word consumer is very important when talking about a profit. A profit always has to do with somebody making a decision to exchange their value for the value of another person.

For example, if I have an iPhone and you have $500 it is possible for a profitable situation to arise. Perhaps I hate my iPhone and would much rather have $500 and you would gladly pay $500 for an iPhone. Well then we can make a trade. And the extremely important point to realize is that in a free market any trade between two parties is completely voluntary. This means that if I trade my iPhone for $500 and you trade your $500 for my iPhone then we are both winning. This is a win/win situation. A profit doesn't mean that somebody loses. It means that both parties win. I win because I value the $500 more than my iPhone and you win because you value the iPhone more than your $500. We both ended in a better situation according to our individual preferences. We both profited.

Let's look more into this.

Making a profit combines goods so the result of these goods is valued more than the parts, labor and time used to produce the end result.

Let me give you an example.

Say it costs me $80 to create a chair. It takes $50 in parts, $20 in labor and then $10 in a factory location to make this chair. And let's say I am able to sell this chair for $100. So the cost to produce is $80 and the price paid by the consumer is $100. The profit would be $20 in this case. Now really think about what I'm about to tell you.

$20 of value is added to society through this purchase.

Somebody voluntarily paid $100 for this chair because they value that chair more than their $100. In their subjective view they are gaining by trading their money for this chair. And I am gaining by selling it to them. We are both winning. But think about this. Without me making this chair those $80 worth of parts, labor and factory location would just be sitting there without a result that somebody wants to pay more than the individual, non-assembled value for all these components. I know it's a bit to wrap your head around. I know it's a different way of normally looking at it. We hear about printing money. With a profit you are in a way printing value. You are creating value out of nothing through innovation.

Think about it this way.

Let's say you are really sick and about to die from a disease. If a cure for this disease doesn't exist you are out of luck and will die. But if I find a way to cure this disease by taking raw resources and adding my expertise of science, chemistry and creativity then I create a product which you have the option of purchasing. And if I sell this cure for $1,000 and it takes me $100 to produce then this $1,000 that you're willing to pay in order to stay alive is $900 of added value to society. I am adding to society by making a profit because I am taking something that isn't valuable on it's own (raw resources, science, chemistry, creativity) and combining in a way where it satisfies a need of a consumer. You would gladly pay $1,000 for this pill and I would gladly sell it to make a huge profit.

Profit is technology

TIMEOUT! But this is exploitation! You're selling it way too high! What if people can't afford it? This gets into a discussion about markets and entrepreneurship which is another very important part to visit.

First of all, without the ability to make a profit I would have never made the pill. So the profit provides an incentive for me to want to pursue certain things that can be profitable once I achieve them.

Second, because of how competition in markets works, as soon as I create this pill and people know about it competitors will immediately enter the market and find a way to re-create this very pill and sell it for less money to take my business. People will back-engineer my pill and sell the same exact pill for $800. Then more people will still enter the market because it is profitable and sell it for $500. And pretty soon the pill will only sell for $50 and cost $40 to produce. The profit margin will get tighter and tighter until the product is super cheap for the consumer. This is a natural market process that occurs in a free market that makes the consumer the winner over time. Over time things get cheaper and higher quality. This is what markets do. It's called ephemeralization. You do more with less until it is eventually free. We've already seen this to a large degree with computers. We don't see this in medicine because medicine is not a free market. Computers are a free market.

So you can't get upset about somebody making a profit in something new because 1) it didn't even exist before and 2) it will get cheaper and cheaper. This is how advancement works. When computers first came out they were the size of a room and cost millions of dollars. Now they are the size of your hand, millions of times faster and hundreds of dollars. What about poor people? They pretty much all have mobile phones now where even 20 years ago only the wealthy did. This whole process is tied to profits. You can't be mad at the first computer costing millions of dollars and the person creating it profiting. The computer never would have existed otherwise. Are you understanding what I'm saying?

Let's talk about something else.

The genius of a free market is what Adam Smith called "The Invisible Hand". There is a brilliant realization that even when people go after making a profit for selfish reasons, like creating a pill to charge lots of money for, this ends up benefiting others. When you create something for selfish reasons in a free market people can choose whether or not to buy that thing you created. If they don't like it then they don't buy it and you don't have a profit, you have a loss. If they do like it then you have a profit. The consumer determines what is valuable and what isn't, not the entrepreneur. This is what I was talking about earlier with the consumer. And it is the amazing technology of a free market operating through profits.

Let's look at it this way: finding and transforming resources into something takes work. We could dig up a lot of oil and turn it into a slip in slide, an oil painting or lots of other things. But the most valuable use currently for oil is using it for energy. And as such, consumers, CONSUMERS, choose voluntarily to buy oil to use in their home, cars, boats and whatever else. People tell entrepreneurs what resources like oil should be used for with their dollars. If it made more sense to use oil for something else then they wouldn't buy oil for their home or car. They do this because this is what they value the most in their life. The same goes for any other resource.

So what this tells us is that the market brilliantly uses resources to the preferences of people. Whatever businesses make a profit on shows that people like what that business is doing with all the components making up their product or service. If you are purchasing a car then you're telling the car company that you like how they use steal, iron, rubber and all the other components of that car. If the car company was making a loss then it would either mean that another car company was able to use those resources more efficiently, or that the car market was a market that people did not desire. And if people didn't want cars then the resources and labor that went into building these cars would re-transform themselves into some other product that better met the needs of consumers. This is the brilliance of the market. Most people don't see it this way. But this is the underlying mechanism working behind the market. It is all based around your choices. And those choices drive where profits happen and where they don't. And things that are profitable get more attention and more people competing in it to drive down the price. And things that aren't profitable go out of business to free up their resources to be used in something that people actually want. And it goes on and on and things get better and better and cheaper and cheaper. Ephemeralization.

The way you profit in a market is by seeing the future better than other people. People who can anticipate what people will want in the future will do very well. And it has to be in an original way that most people don't see. You can't say it is going to be cold in the winter so I'm going to sell jackets. People already know this. This has already been done. People are already in this market servicing this. There isn't a lot of profit there because it has already been done. There is a lot of profit in new markets that you discover and were previously untapped.

Look at Apple. They've killed it since the release of the iPhone because they saw a better way to create phones. Steve Jobs and his team were able to accurately predict the future. Nobody else saw the mobile phone the way Apple did, or if they did they were unable to produce it. But Apple did produce it. They predicted the future correctly, they predicted what people wanted correctly and they profited big time. And shortly thereafter Android came along copying Apple and cutting into their profits. And now Apple has slowly given up their mobile market share to other competitors who can offer something similar for less. And so goes the dance of competition in a new market. The product gets better and the price gets cheaper. And then once day some other entrepreneur has a strike of brilliance as he envisions the future correctly once more. And the cycle continues on and on.

Profit, value, choice and human happiness. That's what a profit is. If you think about it making a profit is one of the most humanitarian things you can do. When you make a profit you are helping somebody. You are adding value to their life. Again, people voluntarily choose to make you a profit. You don't force anybody to buy anything. They choose to buy it. And by choosing to buy it there is a win/win. This is humanitarian. People don't buy what they don't want. People don't buy to make themselves not happy. Most people are okay with a small business making a profit. But when a large corporation makes a profit that is somehow evil. When Apple makes a profit that is okay because they're cool. But when Exxon makes a profit that is greedy and bad because they're exploiting the environment. If they're exploiting the environment then why are people supporting them? Why are people buying their oil? Do you not see the millions of lives that are being saved through the energy provided by fossil fuels? These profits don't come with no positive effects. The pros outweigh the cons.

And guess what? In another 50 years or so fossil fuels will be old news. They will be like the horse and buggy. They will be replaced with something better, cleaner and cheaper. And then I'm sure people will slowly find a way to complain about this again. And then that new form of energy will be replaced too. And once again, the dance of the market continues on.

Profits are not just monetary

And finally, profits don't have to be only monetary. As stated earlier, a profit is basically a surplus. Getting more out than you put in. If you think about money you will realize that money is really just energy. When people make money they exchange their time and labor for money. They exchange their energy for money. And money is the storage of this energy. And when people buy something with money they are basically exchanging that time and labor they spent making that money with for whatever it is they are buying.

So let's look at something like music. Can you make a profit in music? Of course! If I create a song and you listen to it I am profiting through your energy. You aren't paying me money, you are paying me your energy, your time. You are giving me your attention and admiration. I took notes and tones and put them together in a way where the result is better than the parts. You enjoy the result of my song more than the individual components of my song before they were arranged the way that I arranged them. I am profiting. But this profit somehow isn't seen as bad. This isn't seen as exploitive. That's because people don't fully understand what money represents. Money is energy.

You could even say that by you listening to my music I am taking you away from listening to other music. I am hurting other musicians by creating music that you would rather than listen to than others. But of course, nobody complains about this because we are dealing with music instead of money. But it's the same thing. It's energy and where you focus your energy.

Monetary profit is just one possible motivation for people, another may be psychological profit, the ego boost of attention and admiration. These are all profits. And monetary profit isn't the only kind of profit. And when we look outside of monetary profit we don't have alarm bells going off. It's because we understand this better than we do money. We don't understand money at its basic level.

Conclusion

In short, complaining about a person making too many profits is like complaining about a surgeon saving too many lives. It's like complaining about a musician creating too many songs. It just doesn't make sense. When a person makes a profit they aren't hurting anyone. A profit isn't a win/lose. It is a win/win. When a profit is made all parties involved win. You can't possibly be upset about people having preferences, carrying out those preferences and viewing themselves as better because of it.

So are profits bad? Yeah, about as bad as a surgeon saving a life or a musician writing a song.

 Filed under: Economics, Labor & Money, Profit

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