Entrepreneur Profit and Loss

Entrepreneurship Mises University

“Boot Camp” 2015

Timothy D. Terrell

www.timothyterrell.net, @timothyterrell

The Underappreciated Entrepreneur

v  The Austrian School emphasizes the role of the entrepreneur—that person who acts to resolve misallocations of resources in the face of an uncertain future

v  Mainstream economics textbooks neglect the entrepreneur—as did Adam Smith

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Where We’re Going

I.  Consumer Sovereignty and the Economy

II.  Role of the Entrepreneur

III.  Profit and Loss

IV.  Who Is the Entrepreneur?

V.  Final Comments

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Consumer Sovereignty and the Economy

A.   Consumer Demand Determines What Is Produced


Predict future

consumer demand

(re)Design production

process

Acquire resources

to carry out production

Reap residual

(profit) or suffer loss


v  Ludwig von Mises, Profit and Loss (p. 7).

“If [the entrepreneurs] fail to produce in the cheapest and best possible way those commodities which the consumers are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve the consumers replace them.”



A.  Consumer Demand Determines What Is Produced

B.   Imputation and Prices of Production Goods

v  Valuation of goods drives input prices


Preference for diamonds

rises

Price of diamonds

rises

Wages of diamond

miners rise

Demand for high-skill basketball

Price of NBA tickets

Wages of basketball

players



B.   Imputation and Prices of Production Goods

v  Valuation of goods drives input prices


Preference for internet-delivered

movies rises

Demand for physical disk rental falls

Returns to Blockbuster shares fall



B.  Imputation and Prices of Production Goods

C.   Continual Changes in Consumer Preferences, Technology, and Resource Supplies

v  Green tea à Kombucha à Pomegranate juice à ??

v  Geocities à MySpace à Facebook à Pinterest à Instagram à ??

v  People constantly develop different ways of signaling characteristics to friends and clients.






v  Electromechanical switches à vacuum tubes à semiconductors and printed microcircuitry

v  Cargo nets à containerized cargo

v  New combinations of innovations: 3D underground imaging + directional drilling + hydraulic fracturing






v  Shifts in resource availability: relative price changes

v  Population changes

v  Economic growth worldwide

v  Government restrictions, taxes, confiscation


Role of the Entrepreneur

A.   Change, Uncertainty, and Opportunity for Gains

v  Economy is in constant movement, not static

v  Uncertainty presents opportunity for profit



A.  Change, Uncertainty, and Opportunity for Gains

B.   Anticipation of Changes in Preferences

v  Entrepreneur must anticipate preferences

v  observe trends and patterns,

v  understand human psychology

v  understand human tastes

v  Entrepreneur must be prepared to arrange resources now in such a way that a product will be available at just the right time.




B.  Anticipation of Changes in Preferences

C.   Anticipation of Changes in Technology and Resources




“The business of the entrepreneur is not merely to experiment with new technological methods, but to select from the multitude of technologically feasible methods those which are best fit to supply the public in the cheapest way with the things they are asking for most urgently.”




“Whether a new technological procedure is or is not fit for this purpose is to be provisionally decided by the entrepreneur and will be finally decided by the conduct of the buying public.”





C.   Anticipation of Changes in Technology and Resources

v  Note that a new technology is not always best.

v  Government investment in new technologies lacks information about whether the new technology is worth the investment.

v  Opportunity cost of one innovation may be the loss of another innovation.





C.  Anticipation of Changes in Technology and Resources

D.   Entrepreneurs’ Use of Judgment and Appraisal

v  Entrepreneur must use judgment in appraising the current and likely future values of resources and other inputs, and the envisioned final products.


Profit and Loss

A.   Profit as Residual Gain after Factors of Production Paid


Factors

Wages, interest,

rent

Output

Revenue

Revenue – Factor payments Residual + if profit; – if loss

Profit and Loss

A.   Profit as Residual Gain after Factors of Production Paid

v  Capital does not “beget profit,” a la Karl Marx.

v  Capital must be combined with the creative action of the entrepreneur to generate profit, or it is simply inert.

v  More profit for entrepreneurs does not mean lower wages for laborers. (Revenues are not fixed.)

v  We say profit is a “residual,” but that does not mean that it is disposable or unnecessary. Profit and loss are important signals, and incentivize entrepreneurial activity.


Profit and Loss

A.  Profit as Residual Gain after Factors of Production Paid

B.   Incorrect Anticipations Result in Losses

v  Bankruptcy


Profit and Loss


“…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


“…There is a simple rule of thumb to tell entrepreneurs from non-entrepreneurs. The entrepreneurs are those on whom the incidence of losses on the capital employed falls.”


Profit and Loss


B.  Incorrect Anticipations Result in Losses

C.   Difference between Profit and Rate of Interest


Interest •  Exchange rate between present and

future goods

Profit •  Residual after successfully rearranging

resources to meet consumer desires

Profit and Loss


Interest

•  Exchange rate between present and future goods

•  Consequence of time preference

•  Resource owners must be compensated for exchanging goods now for goods later

Profit and Loss



C.   Difference between Profit and Rate of Interest

v  Entrepreneurs may also wear other hats for the firm

v  Entrepreneurial quasi-wages


Profit and Loss



C.  Difference of Profit and Rate of Interest

D.   Profit and Disequilibrium


Profit and Loss


“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.”


Profit and Loss




D.   Profit and Disequilibrium

v  Some needed adjustments may be very large

v  Taxing “excessive profits” is very harmful

v  Profit taxes penalize entrepreneurs who free up resources to be used by others to produce other things


Profit and Loss

v  Ludwig von Mises, Profit and Loss.

“Taxing profits is tantamount to taxing success in best serving the public.”

v  1920 Transportation Act: half of any amount earned by railroads over a “fair return” would be turned over to the ICC. Other, less efficient railroads would be subsidized with those funds.


Profit and Loss




D.  Profit and Disequilibrium

E.   The ERE

v  No uncertainty about the future

v  No entrepreneurship, no profit


Profit and Loss




D.  Profit and Disequilibrium

E.  The ERE

F.   Capitalists and Entrepreneurs


Who Is an Entrepreneur?

v  What remains in the ERE is capitalist activity.

v  Capitalists provide an advance to factor owners, in exchange for taking control of the factors long enough to produce the final product.

v  Capitalists receive more money from consumers than their payments to factor owners. The difference is interest.

v  Because there is no uncertainty in the ERE, there’s no profit, only interest.



“Capitalists who lend money to a business venture may be contractually guaranteed a certain percentage return, regardless of the success of the company, but they know that if the company fails badly enough, it may default on its loan and repay only pennies on the dollar.



“Thus capitalists who lend funds to a business are acting entrepreneurially and must make a judgment on the profitability of the venture before entrusting it with their money.”

-- Robert Murphy, Choice



v  Because entrepreneurship is bound up in the problem of uncertainty, every individually acts entrepreneurially.


Who Is an Entrepreneur? v  Cantillon (1755):

“Entrepreneurs work for uncertain wages, so to speak, and all others for certain wages until they have them, although their functions and their rank are very disproportionate. The General who has a salary, the Courtier who has a pension, and the Domestic who has wages, are in the

Who Is an Entrepreneur? v  Cantillon (1755):

latter class. All the others are Entrepreneurs, whether they establish themselves with a capital to carry on their enterprise, or are Entrepreneurs of their own work without any capital, and they may be considered as living subject to uncertainty; even Beggars and Robbers are Entrepreneurs of this class.”

Summing Up

v  Entrepreneurs are uncertainty-bearers in an economy full of constant change

v  The entrepreneur’s “boss” is the consumer

v  Profits result from accurately predicting the future desires of the consumer, resource availability, technology, and competitive conditions—and acting on those predictions to rearrange factors to satisfy those desires. They are the residual after factors are paid.

v  Taxing profits means less consumer satisfaction. www.timothyterrell.net,

@timothyterrell

Summing Up

v  Losses result from poor entrepreneurial judgment.

v  All of us act entrepreneurially in some capacity.

v  Economics cannot be reduced to a set of equations or actuarial tables. The information the entrepreneur acts upon is often tacit, not in quantitative form.


Final Comments

v  Non-profits

v  Government

v  Political Entrepreneurship

v  Entrepreneurship, Asset Specificity, and Adaptation


Documents

Entrepreneur Profit and Loss