Are big profits a social evil?

In the eyes of most people, business profits, especially large profits, are a bad thing. In 2010, a social survey in the United States found that the majority of people associate large profits with greater social harm [1]. Similar prejudices are also very widespread in our native Bulgaria, further fueled by our recent socialist past. However, few people are able to articulate a logically consistent explanation of what the function of business profits and losses is, how they accumulate, and why and when they are harmful to society. Let us consider these questions from an economic perspective.

As we know, we live in a world in which goods and resources suitable for satisfying human needs are scarce– if they were not, there would be no need to “economize” them at all. For this reason, when certain resources and factors are directed to the production of one good, it means that they cannot be directed to the production of another. This is why, when we discuss the distribution of goods in the economy, it is appropriate to ask ourselves not questions like “would it be better to have more of good A”, but rather: “would it be better to have more of good A and less of other goods that would have to be sacrificed to produce more of A”.

In a free market, only consumers decide which goods to produce and which not to produce. The function of profits and losses is precisely to send a signal to entrepreneurs about which goods consumers think are the best places to focus their efforts.

The profit or loss of a business is determined by the difference between the cost of purchasing the factors of production (labor, capital goods, etc.) and the revenue from the sale of the final product produced with the help of these factors. Profit is possible only when the cost of production is lower than the revenue from the sales of the product. If the cost of production is higher than the revenue, then the business in question registers a loss.

Here we should note that if the future were completely clear and everyone could predict the future economic situation in a market economy with absolute accuracy, it would be impossible for business entrepreneurs to make a profit. In such a world, the prices of the goods needed to produce a given product would fully reflect the eventual price of that product, and in this situation neither profits nor losses would be possible. Profits and losses are possible when the future is unclear and uncertain. The function of the entrepreneur is to try to predict as accurately as possible the future prices of certain goods, formed under the influence of changes in their demand and supply.

If an entrepreneur has made a profit, it means that he has correctly predicted the needs of consumers and has satisfied them better than the competition (or at least part of them). He has realized that there are certain factors of production whose prices are currently much lower than the price of their possible future product. The possibility of a large profit motivates the entrepreneur to purchase these factors and redirect them to the production of products that he believes will be more desirable to consumers in the future compared to others. If he is right, on the one hand he will make a profit, and on the other hand - consumers will be better satisfied than they would be without him. If he is at a loss, it means that he has failed to adequately satisfy consumers - they are not willing to pay enough for his product to cover the costs of production. In this case, the entrepreneur has wasted resources.

Roughly speaking, we can look at profit and loss in the following way: if a business is making a profit, it means that the market has valued its product at a higher level compared to the factors of its production. In other words, something of lower (to consumers) value has been produced into something of higher value. If it is making a loss, the opposite has happened - the product has been valued at a lower level compared to the factors of its production, i.e. something of higher value has been produced into something of lower value.

When a business starts to make serious profits, other entrepreneurs notice this and get involved in the production of a particular good or service. The result of increasing competition is a gradual increase in the quantity of a given good on the market and a gradual decrease in its price. This inevitably leads to lower profits for all entrepreneurs in that field of production.

Greater competition forces companies to strive to optimize their production as much as possible in one way or another - by cutting costs or improving their product. Thus, companies that have the most efficient methods of producing the products most desired by consumers make the largest profits, while those that are not as able to optimize their production and satisfy consumers make smaller or even lose money. The effect of this is that the most capable entrepreneurs have the opportunity to expand their businesses the most.

But the market system can be seriously distorted by state intervention. Nowadays, the state can intervene in practically any sector of the economy in any way it wants and use its legislative and financial power to punish some companies in the market and help others. This is inevitably to the detriment of consumers, because now even if a company is not competitive, if it manages to bribe the political authorities, it can rely on state protectionism. Protectionism can manifest itself in a variety of forms - government procurement, subsidies, changes in the regulatory regime, new laws, and other measures that help companies with political connections to maintain or increase their market share, at the expense of their competition.

In a situation of serious state intervention in the market, the profits of entrepreneurs no longer depend entirely on the judgment of their consumers. The more economic power the state apparatus has, the more each business depends on it and the less on its consumers.

Profits, no matter how large, are not a social evil; on the contrary, as long as they are achieved through efficient production and a well-satisfied consumer base, they perform a key and entirely positive socio-economic function. But when the profits of firms in the market depend more on the decisions of the state bureaucracy than on the decisions of their consumers, then this social function is fundamentally distorted and sometimes even completely dysfunctional.

[1] http://faculty.som.yale.edu/jasondana/antiprofit.pdf

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