Monday, July 8, 2013

Gunnar and Smith

At Gang8, Gunnar writes:

What is the source of profit in a market economy?

The question arises in the following context:
1. Producers pay 1 million for inputs for production.
2. The payment creates employment income of 1 million.
3. Employment income = purchasing power of 1 million.
4. How can sale proceeds of output sold exceed 1 million?

This is more than just a theoretical question on the origin of profit: In the context the same applies to INTEREST on loan capital used in production. By which is meant interest in excess of administrative costs of credit institutions.

In the foundational text of mainstream economics, Paul Samuelson finessed the question:
“It is quite clear that in the real world net revenue [les: profit] is not zero for all firms, nor is it tending towards zero. […] It is clear that this residuum must be “due” to [here comes a sophism that has made a mess of mainstream economics for half a century] something, and it may be labeled by any name we please…” Foundations, p. 87.

At the outset of my work on a Ph.D. thesis at Harvard Economics Department in my younger days, I was curious to ascertain what that “something” might be?

I discovered the answer – but it did not sit well with the Department Head, but that is another story.

The answer is so crystal clear that it takes that special blinkered vision which is the hallmark of economists of the Samuelson school not to see it:

Something which in the nature of things cannot originate in employment income (EI) must originate outside the production sector.

The question concerns purchasing power in excess of employment income and there is but one answer: Purchasing power in excess of employment income (= Profit and interest on loan production capital) must originate as newly created purchasing power within the financial system.

I formatted it a bit, and dropped Gunnar's intro about the Icelandic university student who asked a good question, but I don't think I missed anything relevant in Gunnar's answer. I wanted to shorten it more!

Here's the thing: Gunnar sees producers' profit as outside and apart from the component parts of the price of commodities. Adam Smith saw producers' profit as inside and part of the component parts of price.

If you define producers' profit as outside and apart, then the million that Gunnar's producers pay for inputs for production does not include what they pay themselves. If you define it as inside and part of, then the million does include what producers pay themselves.

So first you decide the answer you want to get, and then you define producers' profit accordingly.

Unfortunately, no matter which way you define it, producers profit *IS* a component part of the price we pay for commodities. So you might as well just define it Adam Smith's way and be done with it.

Gunnar, this means you.

Further reading -- Book I, Chapter VI: "Of the Component Parts of the Price of Commodities" from The Wealth of Nations:

 • At the Library of Economics and Liberty (nice, with numbered paragraphs!)
 • At Bartleby's (3½-page printout)
 • My 1½-page extract

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