Discovery, Value, Price, and Profit
Profit as Greed, Price as Gouging Model
Price
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Profit
Greed
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Discovery, Value, Price, and Profit
Price as Signal Model
Value
Price
Price as Signal, Profit as Incentive Model
Value
Price
Profit
Innovation
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Some Initial Questions on Value
• What determines something’s value?
• When a sale is made, who benefits and who
loses, the buyer or the seller?
• Can wealth (value) be created simply through
trade?
• How much profit, in your opinion, is too
much?
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Theories of Value and Views of the Market
Labor theory of value
 What makes something valuable is the labor
that went into the thing’s production.
Subjective theory of value
 What makes something valuable is that
someone desires the thing.
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Theories of Value and Views of the Market
Labor Theory of
Value
Subjective
Theory of Value
Exchange
zero-sum
win / lose
positive-sum
win / win
Profit or Loss
profit =
(labor) value - wages
profit = new value
created (loss = value
destroyed)
Market
Relationships
exploitation
parasitism
mutual benefit
symbiosis
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Two Kinds of “Profit”
Economic Profit
Legal Plunder
economic means
political means
“make
money”
get money
create wealth
transfer wealth
symbiosis
parasitism
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Discover, Value, Price, and Profit
Price as Signal Model, Profit as Incentive Model
Value
Price
Profit
Innovation
What is innovation?
Who does the innovating?
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What Are Entrepreneurs?
• Higher tolerance for risk.
• Generate novel ideas.
These attributes can also describe the insane.
 Entrepreneurs can be dangerous as well as beneficial.
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What Are Entrepreneurs?
Good Risk vs. Bad Risk (fuzzy definitions)
• Good risk (or “prudent” risk) is risk that is
outweighed by the potential reward.
• Bad risk (or “imprudent” risk) is risk that outweighs
the potential reward.
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What Are Entrepreneurs?
Good Ideas vs. Bad Ideas (fuzzy definitions)
• Good ideas create more value than they consume.
• Bad ideas create less value than they consume.
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CEOs as Entrepreneurs
CEOs are Entrepreneurish
• Expected return is commensurate with risk.
• Stockholders want CEO to take risks (why?)
• CEO has incentive to avoid taking risks (why?)
• If a gamble goes bad, often one does not know
whether the CEO is to blame or whether random
chance is to blame.
• How to incent the CEO to take risks?
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Automobile (think like someone pre-1908)
Good Risk/Idea or Bad Risk/Idea?
Perceived Upsides
Fun, fast, and more comfortable than a horse.
Perceived Downsides
Massive unemployment across multiple industries.
What They Never Considered
Suburbanization. Labor mobility. Gas Stations.
Mechanics. Jiffy Lube. Traffic. Fast Food. Zip Cars.
GPS. Mapquest.
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Personal Computer (think pre-1970)
Good Risk/Idea or Bad Risk/Idea?
Perceived Upsides
People with computing needs have access to
machines: Accounting? Engineering?
Perceived Downsides
People need programming skills to use. Power
consumption. Heat.
What They Never Considered
Internet. Miniaturization. Social Networks. Web
Commerce. eBay. email. iPhone.
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How to Weigh the Good vs. the Bad
Government
Anticipate upside and downside ramifications and
weigh upside vs. downside for society as a whole.
Entrepreneur
Individual consumers decide whether product is worth
the price. Entrepreneur decides whether the expected
profit is worth the risk.
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Drug Company Profits
Celebrex (arthritis treatment)
Price per 100 tablets = $130
Cost of active ingredients = $0.60
Should drug companies be forced to charge lower
prices for their drugs?
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Government and Entrepreneurs are Human
Human Limitations
Limited
Limited
Limited
Limited
information.
ability to evaluate information.
ability to act on information.
ability to react to changes in information.
These limitations exist whether humans are acting in
the roles of entrepreneur or in the roles of government.
Both are going to get it wrong.
 What is important is identifying when we’ve got it
wrong and what to do next.
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Getting It Wrong
Entrepreneurs who get it wrong provide some benefit
in failing by generating information that we might not
otherwise be able to obtain.
The information provides direction to future
entrepreneurs.
It is harder for government programs to fail because
those who decide “failure vs. success” are usually not
those who benefit/lose from the product.
By disconnecting failure from closure, government
prevents people from recognizing and learning from
failure.
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Consequences of Getting It Wrong
Entrepreneur
People don’t buy the entrepreneur’s product and firm
shuts down. Each year, 600,000 firms are born and
550,000 die.
 Each is an experiment in new ways to get it right.
Government
Hundreds of agencies.
Once founded, people who have no use for the
agency’s service and incur no cost for the agency’s loss
have incentive to keep agency going.
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Entrepreneurs Who Got it Right
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Entrepreneurs Who Got it Wrong
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Profit Guides the Entrepreneur
When profit potential rises in one area, entrepreneurs
will be drawn to that area.
The profit that accrues to entrepreneurs is only half the
transaction. What is the other half and to whom does it
accrue?
When an entrepreneur earns a profit, how does the
gain compare to the gain that accrues to customers
who buy the entrepreneur’s product?
Comment on colleges’ calls to alumni to “give back” to
their institutions.
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Allocating Resources
All societies begin as identical except for the manner in which they
allocate resources. You choose the society into which you will be born.
Society A
Allocation by majority vote. Each citizen gets one vote.
Society B
Allocation by majority vote. Each citizen gets one vote plus
one for each living descendent.
Society C
Allocation by majority vote of 10 representatives. Each
citizen casts one vote for a representative.
Society D
People are free to buy/sell resources and their property
rights are protected.
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Society A
Allocation by majority vote. Each citizen gets one vote.
Society B
Allocation by majority vote. Each citizen gets one vote plus
one for each living descendent.
Society C
Allocation by majority vote of 10 representatives. Each
citizen casts one vote for a representative.
Society D
People are free to buy/sell resources and their property
rights are protected.
How would resources be allocated differently in the different societies?
In response to changed circumstances, how quickly could the societies
redirect their resources?
How well off would people be in the short run and the long run?
Into which society would you choose to be born?
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Why the Government Can’t Run a Business
• Governments use other people’s money.
Corporations use their own money and so pay for
their mistakes. In using other people’s money, the
cost of government’s mistakes are born by others.
• Government does not tolerate competition.
Government entities do not compete on a level
playing field with private entities.
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Why the Government Can’t Run a Business
• Successful businesses are run by benevolent despots.
Government was deliberately designed to be
inefficient so that it could not be run by a despot.
• Government is regulated by government.
Government’s job is to make and enforce rules that
allow a civilized society to flourish. But, government
has a dismal track record at regulating itself.
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Public Education
Annual cost per student: $6,800
Private elementary school
Annual cost per student: $2,500
Private elementary and secondary school
Annual cost per student: $3,100
Source: National Center for Education Statistics (figures are for 1996)
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Amtrak
Spent $160 million on food that it sold for $80 million.
Losses on food service equal 20% of annual subsidy.
Sunset Limited (Los Angeles to Orlando) generates a
$35 million loss. Amtrak could save money by shutting
down the line and giving complementary airline tickets
to the 81,000 passengers who travel this line.
Total annual loss = $1 billion.
Source: US Department of Transportation, Report on the Analysis of Cost Savings on Amtrak’s Long-Distance Services, 2005.
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U.S. Postal Service
Delivers 200 billion pieces of mail per year.
Annual loss: $3 billion
FedEx
Delivers 3 billion packages per year.
Annual profit: $1 billion
UPS
Delivers 6 billion packages per year
Annual profit: $4 billion
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Medicare
Annual loss: $500 billion
Projected loss over next 30 years: $100 trillion
Blue Cross Blue Shield
Annual profit: $400 million
Kaiser Permanente
Annual profit: $600 million
Aetna
Annual profit: $1.5 billion
United Healthcare
Annual profit: $120 million
Humana
Annual profit: $2 billion
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$100
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$10,000
A stack of $100 bills, ½ inch high.
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Adapted from pagetutor.com
$1 million
100 packets of $10,000.
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Adapted from pagetutor.com
$100 million
$100 million fits on a standard pallet.
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Adapted from pagetutor.com
$1 billion
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Adapted from pagetutor.com
$1 trillion
About twice the amount of money the U.S. government spends on interest on
the national debt in one year.
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Adapted from pagetutor.com
$12 trillion
The value of all goods and services produced in the United States in one year.
Also, the U.S. national debt (as of 2009).
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Adapted from pagetutor.com
$100 trillion
Amount of unfunded Social Security and Medicare obligations (as of 2009).
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Adapted from pagetutor.com
Annual Losses
Amtrak = $ 1 billion
Postal Service = $3 billion
Medicare = $500 billion
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Evolution in Natural and Economic Systems
Source of
Variation
Means of
Selection
Biology
mutation, sexual
reproduction
natural selection,
survival of the fittest
Economy
entrepreneurial
innovation
profit and loss
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Private Property is Necessary
Private property is necessary because some resources
must not be used.
To incent a person to forego using a resource in the
present, the person must be able to use the resource
in the future.


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Christmas Trees
Cows
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Why Economic Liberty?
• Free market prices communicate dispersed
knowledge.
• Profit and loss guide discovery of ever new and
better ways of satisfying human wants.
• Incentives and information.
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“Profit and loss are the instruments by means of
which consumers pass the direction of production
activities into the hands of those who are best fit to
serve them.”
Ludwig von Mises
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