Capital Goods and Capital

Is Profit a four-letter word?

I recently heard Lorne Calvert speak about the possibility of a native owned and operated MRI clinic in Saskatoon. He said that he was willing to accept the idea of a private MRI clinic as long as it was a not-for-profit clinic. His tone and words made it obvious that "profit" is a dirty word to him, especially when connected with the healthcare industry. This shows that Mr. Calvert has a complete lack of understanding of the role that profits (and losses) play in the economic system.

This observation then begs the question, what is the role of profits & losses in the economic system?

The definition of Profit that we will use is the excesses of returns over expenditure in a transaction or series of transactions, the excess of the selling price of goods over their cost.

We can use the analogy of the lemonade stand business to illustrate what profits are and how they work in our economy. Lets assume that little Johnny sets up a lemonade stand at the beginning of summer. He uses his savings from his piggy bank and purchases the goods and material he needs to go into business. He begins producing and selling glasses of lemonade for one dollar. After paying for the goods and material that he needed to start and run his business he makes a profit of $.15 per glass of lemonade, at 100 glasses per day. As the days get hotter he notices an increase in business to 120 glasses per day. The extra business is getting tougher for him to handle, so he raises his prices to $1.25 per glass. This increase in prices slows his traffic to 110 glasses per day, but the extra money increases his profits overall. So now he is making an overall profit of $44.00 per day compared to $15.00 per day before the increase.

Little Mary down the street notices how well little Johnny’s stand is doing compared to her cookie business. She sits down with her calculator and decides that she could make a good profit by using only fresh squeezed lemons in her lemonade, (and charging a premium price) instead of the lemon juice from a can that little Johnny is using. She goes to her brother (an investor) to borrow the money needed to setup her own lemonade stand. Once she is in business she sells her lemonade for $2.00 per glass. She soon has a great deal of business (remember, the days are getting hotter and the demand for lemonade is getting larger.) Soon Charlie on the next block decides that lemonade stands is the business for him as well. He finds that if he purchases artificial lemon juice instead of real lemon juice in a can, he can sell the glasses of lemonade much cheaper. He borrows some money from his father and some from his own savings and starts his cut rate lemonade business, selling glasses of artificial lemonade for $.75 per glass. He soon has a great deal of business from the people who could not afford the premium and mid priced lemonade.

More young entrepreneurs see that the rate of profit in the lemonade business is higher than other businesses because of the demand for the product/service. This encourages them to invest their capital in lemonade stands rather than other forms of businesses because they are seeking the greatest rate of return on their capital possible. This is in line with what consumers want. Consumers are spending their money as they see fit, and they see fit to spend it on lemonade rather than on cookies or something else. As they do so they are causing the rate of profit in the lemonade business to go up, thus attracting more capital and investment into that business. As more capital and investment goes into the lemonade business, more glasses of lemonade will be produced at a price that consumers are willing to pay and in doing so, satisfying the demand of the consumers. This improves their standard of living

As the summer goes on more stands are set up until all the niches are filled and the competition begins to force some of the stands to cut prices in order to keep market share. At this point no more entrepreneurs want to set up lemonade stands because the rate of profit is no longer high enough to compete with other potential businesses. This is the point where consumer demand for glasses of lemonade (at the prices offered) is essentially satisfied. The entrepreneurs already in the lemonade business will work very hard to lower their costs so they can cut the selling price of lemonade without incurring an operating loss. As this happens, the cost of a glass of lemonade to the consumer will begin to go down, even for the premium product. This results in a lower cost to the consumer who usually increases his consumption of the cheaper product thus increasing his standard of living.

So in the end we can see that all profits are doing is directing capital and investment towards the lines of production of goods and services that consumers most want. Consumers are showing us what they want by using their money to purchasing these goods and services.

When Lorne Calvert prevents entrepreneurs from setting up and operating MRI clinics, what he is doing is preventing Saskatchewan consumers from purchasing the goods and services that they want and are willing to pay for. He is showing contempt for grown adults in this province. He believes that he and his government bureaucracy know better than you do, how you should spend your own money. Can you imagine if the government was running the lemonade stands in Regina? I can, just look how they run the healthcare industry. The lineups at the stands would be miles long and it would be mostly unavailable, even on the hottest days.