The Price System, Part 2: Profits & Losses

What is the social function of profits and losses? As Prof. Daniel J. Smith of Troy University describes, they provide an incentive for people to follow the information provided by the price system. By pursuing profits and avoiding losses, producers and consumers use scarce resources in effective ways. In anticipation of being rewarded with profit, people and businesses are encouraged to undertake activity that will create valuable outputs. At the same time, the potential for losses encourages them to avoid excessive risks and wasteful activity. Policies that reduce profits, such as taxation, or reduce losses, such as bailouts, disrupt this function of prices and lead to inefficient uses of resources.

3 Comments

  1. Matt Wavle

    I would take exception to the parallel offered, that the bankruptcy is just the market working is just like a politician getting voted out of office is just the electoral process working.  Many good politicians get replaced by bad ones, majorities are not always the best way to choose.   

  2. [email protected]

    I think he is limiting the metaphor to the feedback of the politician that is not reelected rather than speaking to who takes his place. 

  3. Mike Hines

    Allan Mulally at Ford took a significant number of steps in order to avoid bankruptcy. GM and Chrysler didn’t take those steps and went bankrupt, and got very favorable treatment with intervention from the executive branch.  The incentive here tells me Mulally made a mistake. He should have continued to spend on plant and equipment, gone bankrupt, and gotten many of his debts forgiven (like GM and Chrysler), thus getting the government’s help in getting ‘free’ capital improvements for Ford. 

    I would like to be able to peek into that alternate universe where GM and Chrysler went bankrupt under the existing law, without interventions. What would the auto industry look like now I wonder?

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