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Profit: One way to get it right, many ways to get it wrong

We have two criteria to assess a theory: material consistency and formal consistency. A theory must satisfy both  criteria, that is to say, it can be rejected either on empirical or on logical grounds alone.

 

From the structural axioms and definitions follows the monetary profit for the business sector as a whole in the case of an investment economy:

 

 

 

Total monetary profit in period t is given by the difference of business sector’s investment expenditures and household sector’s monetary saving  plus distributed profits of the business sector. Overall profit is spread among firms in the process of competition.

 

As a consequence, the following statements have to be rejected on purely formal grounds:

 

Smith: Wages, profit , and rent, are the three original sources of all revenue as well as of all exchangeable value. (2008, p. 50)

 

Ricardo: … profits would be high or low in proportion as wages were low or high. (1981, p. 110)

 

Senior: In the second class we have the words Capital, Capitalist, and Profit. These terms express the instrument, the person who employs or exercises it, and his remuneration; but there is no familiar term to express the act, the conduct of which profit is the reward, and which bears the same relation to profit which labour does to wages. To this conduct we have already given the name of Abstinence. (1854, 4.9)

 

Mill: The cause of profit is, that labour produces more than is required for its support. (2006, p. 411)

 

Marx: Hence, if a commodity is sold at its value, a profit is realized, which is equal to the excess of its value over its cost-price, or equal to the entire surplus-value incorporated in the value of the commodity. (1909, I. I. 31)

 

Jevons: I think that in the equation Produce=profit+wages, the quantity of produce is essentially variable, and that profit is the part to be first determined. (1911, p. 270)

 

Marshall: The normal earnings of management are of course high in proportion to the capital, and therefore the rate of profits per annum on the capital is high, when the work of management is heavy in proportion to the capital. (2009, p. 508)

 

Knight: The presence of true profit, therefore, depends on an absolute uncertainty in the estimation of the value of judgment, or on the absence of the requisite organization for combining a sufficient number of instances to secure certainty through consolidation. (2006, p. 285)

 

Schumpeter: And since the new combinations which are carried out if there is “development” are necessarily more advantageous than the old, total receipts must in this case be greater than total costs. (2008, p. 129)

 

von Mises: The ultimate source from which entrepreneurial profit and losses are derived is the uncertainty of the future constellation of demand and supply. (2007, p. 293)

 

Keynes: Thus the factor cost and the entrepreneur’s profit make up, between them, what we shall define as the total income  resulting from the employment given by the entrepreneur. (1973, p. 23), original emphasis

 

Hicks: The curve IS can therefore be drawn showing the relation between Income and interest which must be maintained in order to make saving equal to investment. (1937, p. 153)

 

Harrod: The relevant propositions may be stated in the form of truisms or tautologies, such as that the price of an article is equal to the sum of rewards to all persons contributing to its production, ... (1938, p. 392)

 

Shackle: Thus it seems that we might select decision-making and uncertainty-bearing as the economic roles to perform which men come forward because of the prize of profit in the sense we have been discussing. (1955, p. 226)

 

Samuelson: GDP, or gross domestic product, can be measured in two different ways: (1) as the flow of final products, or (2) as the total costs or earnings of inputs producing output. Because profit is a residual, both approaches will yield exactly the same total GDP. (1998, p. 392)

 

Debreu: … the consumers own the resources and control the producers. Thus, the ith consumer receives the value of his resources … and the shares … of the profit of the 1st, …, jth, …, nth producer. … Consider a private ownership economy E . When the price system is p, the jth producer tries to maximize his profit on Yj. Suppose that yj does this; the profit pj(p) = p • yj is distributed to shareholders. (1959, pp. 78-79)

 

Arrow and Hahn: Given a set of prices for all commodities, it is possible to calculate for each activity its profit, the excess of the values of its outputs over the value of its inputs; … The assumptions of perfect competition imply that … each firm chooses an activity that yields it at least as much profit as any other possible. (1991, p. 53)

 

Kaldor: Income may be divided into two broad categories, Wages and Profits (W and P), where the wage-category comprises not only manual labour but salaries as well, and Profits the income of property owners generally, and not only of entrepreneurs; (1956, p. 95)

 

Kalecki: Gross profits = Gross private investment + Capitalists’ consumption. (1942, p. 259)

 

Sraffa: This is because the surplus (or profit) must be distributed in proportion to the means of production (or capital) advanced in each industry; and such a proportion between two aggregates of heterogeneous goods (in other words, the rate of profits) cannot be determined before we know the prices of the goods. (1979, p. 6)

 

Boland: The Walrasian prices correspond to the Marshallian long-run equilibrium prices where every producer is making zero excess profits. Thus, since in the short-run non-zero profit is possible, the actual short-run prices cannot always be used for aggregation. But, from the macro perspective of Walrasian general equilibrium, the total  profits in this case cannot be other that zero (otherwise, we would need a Santa Claus to provide the aggregated positive profit) but this does not preclude the possibility of short-run profits and losses of individual firms canceling each other out. (2003, p. 150), original emphasis

 

Minsky: The simple equation “profit  equals  investment”   is the fundamental relation for a macroeconomics that aims to determine the behavior through time of a capitalist economy with a sophisticated, complex financial structure. (2008, p.  161), original emphasis

 

Barro: Households receive income in four forms: profit …, wage income, rental income, and interest income. (2008, p. 131)

 

Wickens: Implicit measure of profits Πt = -kt+1 +(1+θ)kt . (2008, p. 82)

 

Ljungqvist and Sargent: In each period, the representative firm takes (rt, wt) as given, rents capital and labor from the households, and maximizes profits: Π=F(kt, nt)-rtkt-wtnt. (2004, p. 484)

 

Nadal: ... the budget constraint of consumers may be undetermined because it incorporates their share of firms' profits, which may not be defined. (2004, p. 39)

 

Keen: … net annual income in this simple model equals the sum of wages plus profits. (2011, pp. 366, 146)

 

 

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With regard to profit, economists since Adam Smith have been groping in the dark.

 

At all times, including the present, in judging from the standpoint of the requirements of each period ... the performance of economic theory has been below reasonable expectation and open to valid criticism. (Schumpeter, 1994, p. 19)

 

Not one of the quoted books contains the correct profit theory, and the compilation is far from complete.

 

 

References

Arrow, K. J., and Hahn, F. H. (1991). General Competive Analysis. Amsterdam, New York, NY, etc.: North-Holland.

Barro, R. (2008). Macroeconomics: A Modern Approach. Mason, OH: Thompson South-Western.

Boland, L. A. (2003). The Foundations of Economic Method. A Popperian Perspective. London, New York, NY: Routledge, 2nd edition.

Debreu, G. (1959). Theory of Value. An Axiomatic Analysis of Economic Equilibrium. New Haven, London: Yale University Press.

Harrod, R. F. (1938). Scope and Method of Economics. Economic Journal, 48(191): 383–412. URL

Hicks, J. R. (1937). Mr. Keynes and the "Classics": A Suggested Interpretation. Econometrica, 5(2): 147–159. URL

Jevons, W. S. (1911). The Theory of Political Economy. London, Bombay, etc.: Macmillan, 4th edition. Online-version URL

Kaldor, N. (1956). Alternative Theories of Distribution. Review of Economic Studies, 23(2): 83–100. URL

Kalecki, M. (1942). A Theory of Profits. Review of Economic Studies, 52: 258–267. URL

Keen, S. (2011). Debunking Economics. London, New York, NY: Zed Books, rev. edition.

Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London: Macmillan.

Knight, F. H. (2006). Risk, Uncertainty and Profit. Mineola, NY: Dover. (1921).

Ljungqvist, L., and Sargent, T. J. (2004). Recursive Macroeconomic Theory. Cambridge, MA, London: MIT Press, 2nd edition.

Marshall, A. (2009). Principles of Economics. New York, NY: Cosimo, 8th edition. (1890).  Online-version URL

Marx, K. (1909). Capital: A Critique of Political Economy, Vol. III. The Processof Capitalist Production as a Whole. Library of Economics and Liberty. URL

Mill, J. S. (2006). Principles of Political Economy With Some of Their Applications to Social Philosophy, volume 2, Books I-II of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund. (1866). Online-version URL

Minsky, H. P. (2008). Stabilizing an Unstable Economy. New York, NY, Chicago, IL, San Francisco, CA: McGraw Hill, 2nd edition.

Nadal, A. (2004a). Behind the Building Blocks. Commodities and Individuals in General Equilibrium Theory. In F. Ackerman, and A. Nadal (Eds.), The Flawed

Foundations of General Equilibrium, pages 33–47. London, New York, NY: Routledge.

Ricado, D. (1981). On the Principles of Political Economy and Taxation. The Works and Correspondence of David Ricardo. Cambridge, New York, NY, etc.: Cambridge University Press. (1821). Online-version URL

Samuelson, P. A., and Nordhaus, W. D. (1998). Economics. Boston, MA, Burr Ridge, IL, etc.: Irwin, McGraw-Hill, 16th edition.

Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

Schumpeter, J. A. (2008). The Theory of Economic Development. An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. New Brunswick, NJ, London: Transaction Publishers. (1934).

Senior, N. W. (1854). Political Economy. Library of Economics and Liberty. URL

Shackle, G. L. S. (1955). Expectation, Income and Profit. Ekonomisk Tidskrift,57(4): 215–234. URL

Smith, A. (2008). An Inquiry into the Nature and Causes of the Wealth of Nations. Oxford: Oxford University Press. (1776). Online-version URL

Sraffa, P. (1979). Production of Commodities by Means of Commodities. Prelude to a Critique of Economic Theory. Cambridge, London, etc.: Cambridge University Press.

von Mises, L. (2007). Human Action. A Treatise on Economics, volume II. Indianapolis, IN: Liberty Fund. (1949). Online-version URL

Wickens, M. (2008). Macroeconomic Theory. A Dynamic General Equilibrium Approach. Princeton, NJ, Oxford: Princeton University Press.

 

 

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Refers to Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist, Sec. 4  URL, see also Debunking squared  and  Profit for Marxists  URL. The theory of profit affects, first of all, the familiar ideas about the functioning of the market mechanism (for details see The Law of Supply and Demand: Here it is Finally  URL).

 

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