Discovery, Value, Price, and Profit

Discovery, Value, Price, and Profit Profit as Greed, Price as Gouging Model Price Profit Greed

Discovery, Value, Price, and Profit Price as Signal Model Value Price Price as Signal, Profit as Incentive Model Price Profit Value Innovation

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? Some Initial Questions on Value

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.

Labor Theory of Value Subjective Theory of Value Exchange zero-sumwin / lose positive-sumwin / win Profit or Loss profit = (labor) value - wages profit = new value created (loss = value destroyed) Market Relationships exploitationparasitism Theories of Value and Views of the Market mutual benefitsymbiosis

Economic Profit Legal Plunder economic means political means “makemoney” get money createwealth transfer wealth symbiosis parasitism Two Kinds of “Profit”

Discover, Value, Price, and Profit Price as Signal Model, Profit as Incentive Model Price Profit Value What is innovation? Who does the innovating? Innovation

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.

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.

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.

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?

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.

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.

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.

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?

Government and Entrepreneurs are Human Human Limitations Limited information. Limited ability to evaluate information. Limited ability to act on information. Limited 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.

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.

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.

Entrepreneurs Who Got it Right

Entrepreneurs Who Got it Wrong

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.

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.

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?

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.

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.

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)

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.

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

Medicare Annual loss: $500 billion Projected loss over next 30 years: $100 trillion Blue Cross Blue Shield Annual profit: $400 million Aetna Annual profit: $1.5 billion Humana Annual profit: $2 billion Kaiser Permanente Annual profit: $600 million United Healthcare Annual profit: $120 million

$100

$10,000 A stack of $100 bills, ½ inch high. Adapted from pagetutor.com

$1 million 100 packets of $10,000. Adapted from pagetutor.com

$100 million $100 million fits on a standard pallet. Adapted from pagetutor.com

$1 billion 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. 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). Adapted from pagetutor.com

$100 trillion Amount of unfunded Social Security and Medicare obligations (as of 2009). Adapted from pagetutor.com

Annual Losses Amtrak = $ 1 billion Postal Service = $3 billion Medicare = $500 billion

Evolution in Natural and Economic Systems

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.  Christmas Trees  Cows

Free market prices communicate dispersed knowledge. Profit and loss guide discovery of ever new and better ways of satisfying human wants. Incentives and information. Why Economic Liberty?

“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

Discovery, Value, Price, and Profit