Whether it's Nation of Islam Minister Louis Farrakhan leading the Million-Man March, anti-WTO (World Trade Organization) protesters, or AIDS activists, we're frequently treated to the chant demanding "People Before Profits." Since profit demagoguery is a deceptively appealing tool used by scoundrels everywhere, let's demystify the concept of profits.
Let's first get its definition out of the way. Profits represent the residual claim earned by entrepreneurs. It's what's left after all other costs-wages, rent, interest-have been paid. The entrepreneur is generally seen as the person who takes risks, innovates, and makes decisions. It's important to recognize that profits are a cost of business just as are payments to labor, land, and capital. If wages, rent, and interest are not paid, labor, land, and capital will not be offered; similarly, if profit is not paid, entrepreneurs won't be seen either.
Roughly six cents of each dollar companies take in represent after-tax profits. By far, wages arc the largest part of that dollar, representing about 60 cents. As percentages of 2002 national income, after-tax profits represented about 5 percent and wages about 71 percent. Far more important than simple statistics about the magnitude of profits is the role played by profits, namely, that of guiding resources to their highest-valued uses, determined nut by some tyrant but by ordinary people's wants and desires. Let's discuss just a few examples.
Remember when Coca-Cola introduced the "new" Coke? Pepsi president Roger Enrico called it "the Edsel of the 80s," representing one of the greatest marketing debacles of the decade. Who made the Coca-Cola Company bring back the old Coke? Was it Congress, the courts, the President, or other government officials who claim to have our interests at heart? No way. It was the specter of negative profits (losses) that convinced Coca-Cola to bring back the old Coke. Thus one role of profits is to discover what consumers want. If producers make mistakes, profits work to correct them.
After the 1992 massive destruction caused by Hurricane Andrew, South Florida stores sold sheets of plywood for twice the price it had sold for prior to the storm. Escalating plywood prices brought charges of price-gouging and prosecutory threats. But look what higher prices and the potential for windfall profits did. Plywood destined to be shipped to the Midwest, West, and Northeast suddenly was rerouted to South Florida. Lumber mills increased production. Truckers and other workers worked overtime so as to increase the availability of plywood and other construction materials to Floridians. Rising plywood prices meant something else. All that plywood heading south meant plywood prices rose in other locations, thus discouraging "less valued" uses of plywood, such as home-improvement projects. …