The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along.
It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.
READINGS: Chapters 6 & 7 from Gene Callahan’s Economics for Real People and Chapter 7 of Thomas Taylor’s An Introduction to Austrian Economics
1 What is the difference between profit and interest?
The market establishes an interest rate for the long-term use of, say, capital goods or funds loaned out, but profit consists in a rate of return above the market interest rate. If an entrepreneur is only earning the interest rate they aren’t really profiting.
2 Which imaginary construction is useful for illustrating this difference?
The ‘evenly rotating economy’, in which goods and services are provided in the exact same amounts day-in and day-out. There is never an increase or decrease in demand for anything, and a lettuce farmer knows exactly how much lettuce they need to grow, what price they can command for it, and what expenditures will need to be made on resources like fertilizer.
In a situation like this it is possible to earn interest but not to earn profit. Earning a profit requires an entrepreneur to spot opportunities by correctly forecasting supply and demand. If nothing ever changes there is nothing to forecast; all supply and all demand is known in advance by everyone.
3 How do Austrians justify the use of imaginary constructions?
Imaginary constructions are just a kind of thought experiment. We use imaginary constructions insofar as they elucidate some aspect of the economy which otherwise might be hard to focus on amidst the blooming, buzzing confusion of the actual market.
Having established the concept of an evenly rotating economy in the question above, we might then imagine one solitary change (a sudden increase in the demand for ice cream), and then ask ourselves what happens as a result.
This procedure clearly abstracts away vast amounts of complexity, but if we do it carefully there’s no reason to think that nothing can be learned.
4 Is there a “normal rate of profit” in a market economy?
The ‘normal’ profit is just the profit made from interest. All things being equal people would prefer $1,000 today for $1,000 next year, so if I invest $1,000 in a venture to be cashed out in one year I expect to make back more than I put in. Of course this kind of profit exists in a market economy.
The normal rate of profit is contrasted with entrepreneurial profit, which consists primarily of adjusting the structure of production to better meet consumer demand.
5 In what sense is all action entrepreneurial?
Most people think of someone like Elon Musk or Jeff Bezos when they hear the word “entrepreneur”, but Mises noted that as a kind of activity entrepreneurship really just means acting in the face of a future made uncertain by shifting market conditions. Since none of us possesses a crystal ball by which to divine what’s coming, we are all entrepreneurs in this regard.
6 How does entrepreneurship relate to consumer satisfaction?
Entrepreneurs are the class of people who look at the ways in which the current configuration of the economy fails to maximize consumer satisfaction as much as it could and act to change this. If people are not getting all the designer jeans, handmade soap, or bee pollen extract that they want some entrepreneur will see this and invest time, money, and capital resources in supplying the demand.
7 What is the connection between disequilibrium and entrepreneurship?
In an evenly rotating economy there would be no role for entrepreneurs because everyone has exactly as much of everything as they want. It is only in a state of disequilibrium, when there are needs unmet, opportunities unseen, and resources un-utilized that entrepreneurs have anything to do.
8 What does “market process” mean?
The ceaseless churning of market activity. The constant buying, selling, trading, renting, consuming, leasing, paying, and so forth which all of us engage in on a daily basis.
9 What does Mises say is the “ultimate source” of profits and losses?
The uncertainty of the future. In an evenly rotating economy nothing ever changes and everything is known in advance, so there is no possibility of making a profit or taking a loss. But in a dynamic economy there is much uncertainty about the future, so anyone can take their savings and invest in a new venture if they anticipate that future demand for their product or service will exceed their current expenditures. Sometimes they will predict correctly, sometimes they will predict incorrectly, but it is this lack of omniscience which gives rise to profit and loss.
10 Isn’t it true that one man’s profit is another’s loss?
No; economic activity needn’t be zero-sum. Of course it is possible for one man to profit at another’s expense, but this should not be our default assumption. When a person makes exorbitant profits it is most likely that they are providing a superlative good or service which many, many people are willing to pay for. Capitalism is unique in its effectiveness at channeling ‘greed’ toward pro-social ends.