Is Profit Bad?

Almost exactly five years ago, I was sitting in a training seminar for my first big girl job. Fresh out of school, I was intrigued by the industry I would be working in and the high caliber of technically trained engineers and economists I would be working with. The topic of the seminar was an introduction to the basics of our market. I sat next to an older gentleman who was also new to the company. He was friendly and enthusiastic, and I enjoyed chatting with him during the interactive portions of the seminar. It didn’t take long, however, before his enthusiasm waned. We had just finished a module describing virtual trading and arbitrage. I do not remember this gentleman’s exact words, but I will never forget the visceral distress he suddenly experienced as he turned to me and said something along the lines of “They make money by not producing anything?? Isn’t that a scam?”

The point of this discussion is not to discuss the mechanics of virtual trading and price arbitrage in particular, although that topic is fun and may very well be the subject of another post. What was so strongly impressed upon me in that moment was that here was an individual several decades my senior who was, no doubt, highly educated, well-trained, and qualified to be working for this company, who did not understand the purpose or role of financial or economic profit. To make matters worse, he had a reached a moral conclusion, based on an incomplete understanding, that caused him emotional distress. 

The idea of profits and profit-making is often villainized, I’ve noticed, in our culture. Profits are often associated with foul play and greed. To an observer, something about profits can appear or feel distinctly unfair. Interestingly, this inherent sense of moral injustice is directly proportional to the quantity of the profit. Maybe a little profit is okay, but definitely not a lot of profit. A lot of profit must be bad (incidentally, at what quantity does profit switch from “maybe okay” to “bad”?) 

Have you ever heard, or perhaps thought and believed yourself, any of the following?

“People over profits.”

“They only care about their bottom line.”

“That organization is a nonprofit, that’s how we know they’re not in it for the money.”

If that’s you, I would like to invite you to contemplate the following question: Why do I feel and believe that profits are unfair? What is my reasoning?

I submit my humble argument for your consideration, and it is this: profits are neither good nor bad. Like money itself, profits are morally neutral. However, let’s go a layer deeper. There is much that could be said about the role of profits in economics, but I’d like to focus on two ideas only: the basic purpose of profits, and one of the reasons why, I suspect, profits trigger moral discomfort in many of us. 

From a purely economic perspective, profits are signals. Signals of what? Value creation. What do I mean by value creation? I mean that whoever is earning the profit has just created some product or service that provides value to to someone: they have created something that people want. How do we know this, just from the presence of profits alone? Let’s take a look at the most basic definition of profit:

Profit = Total Revenues – Total Costs

Profits, by definition, occur when the total money received from producing the product or service is greater than the total costs it took to produce that product or service. 

Total Revenues > Total Costs

To understand why this is so significant, let’s imagine a scenario in which I decide I would really like to make some profit. All I have to do is make something and convince people to buy it and voila! I make profits, right? Let’s imagine I decided to make tennis balls, and I decide to make them out of lead. It costs $10 in labor and materials to make each lead tennis ball. If I want to make a profit, this means I have to sell the lead tennis ball for more than $10. Theoretically speaking, I have to sell it a minimum of $10.01 to make a profit of $0.01. If I sell it for $10, I break even. I have essentially just volunteered my time and energy to make something for someone else, at no benefit to me, when I could be doing something else with my time and energy.

Now, as I’m sure you’ve already surmised, a lead tennis ball is a terrible product. It’s a bad idea. Tennis balls need to be light and bouncy to be used in the game of tennis, and clearly lead has the opposite characteristics, rendering the tennis ball useless. What’s more, lead is a fairly expensive metal, as it costs $10 to make each one (in this imaginary example). However, let’s say that I manage to convince a few people to buy my product – maybe they like the idea of a tennis ball-shaped paperweight. But here’s the catch – are they willing to pay at least $10 for it? Sadly, no. Paperweights can be acquired at a much lower price. Let’s say they agree to pay $3 for my lead tennis ball. Have I made any profits?

Total Revenue = $3

Total Costs = $10

$3 – $10 = -$7

Of course, I haven’t made any profits. I haven’t even broken even. I have lost $7, which is not quite as bad as selling zero lead tennis balls and losing $10, but certainly not desirable. I’ve made negative profits, or losses.

While this example may seem elementary, its simplicity becomes profound when we take a step back and consider the phenomenon of profits on a macro scale. In this scenario, what is the negative profit signaling to us? It’s signaling that the costs to make the product are greater than the benefits to people. It’s not worth it. Not only is it not worth it because it’s hurting the producer, it is misusing and wasting the scarce resources that it took to produce it, including the labor costs, lead costs, and the time and energy the producer took to make it. Those resources, once used, cannot be retrieved. They could have been used for other things, things that make profits, and they were not. 

You may also be wondering – wait a minute. Why must the buyer of the lead tennis ball pay more than $10 in order to create profit? Isn’t that fundamentally unfair? Shouldn’t they only be expected to pay $10?

This is a very good question. It is a deep question which has been the subject of many books and would once again be a great topic for its own post. The short answer is “no.” The most basic reason is that the buyer pays not according to the costs it took to produce the product, but according to how much they value the product. Every buyer has a range in which they are willing to pay for something. There is a price that is too high, where the product is not worth it to them. There is also a price that is low, where they would be willing to pay more for the product, but the seller is charging less than that amount, and so the buyer is getting a good deal. What’s going on here? The basic idea is that the product or service being created for the buyer is more valuable to them than if they went out and tried to use their time, energy, talents, and materials to do or create that thing themselves. Even in the scenario of the lead tennis ball, for those who desired that terrible product for an aesthetically pleasing paper weight, they saw value in purchasing the paper weight for $3 instead of going out and trying to get the lead, the labor and spend the time figuring out how to make the paper weight themselves. 

Put simply, profits are a signal to us that the benefits of creating something outweigh the costs – and we should keep making that thing. Value is created. The profit is a signal that the value of the product or service is greater than the sum of the inputs of resources and time it took to make it. How miraculous! Similarly, negative profits, or losses, are a signal to us that the costs of creating something outweigh the benefits – and we should stop making that thing. We are wasting resources that would be better diverted to an alternative – a profitable – use. 

I will end on an observation about why we feel moral discomfort at the prospect of profits. I don’t know about you, but when I first learned about the role of profits in economics, I got excited. I thought, wow! It was tempting for me to think that profits are good because they are a highly informative signal showing us how to use, and not waste, scarce resources. But I stand by my claim that profits are, in fact, morally neutral. This is because it is equally tempting for a casual observer to see profits being created in contexts that they themselves do not agree with or like, and therefore conclude that the profits themselves must be bad. 

For example, one may disagree with a legal drug such as marijuana, and view the extremely profitable marijuana companies as being “bad” for making profits off of a drug that you believe to be bad. On the opposite end of the spectrum, consider the rags-to-riches story of a starving artist who finally begins to make profits selling her beautiful paintings to happy buyers. Surely, those profits are good, right? 

If we consider the claim that profits are actually neutral in both cases, that suggests that it is people’s choices that we consider to be good or bad, and not the profits themselves. Profits are merely signals that resources are being used to create something that is valued higher than the resources’ costs. But what we as individuals and a society choose to value is entirely up to us. 

I leave you with this thought: profits are created solely from the choices we make in what we choose to value.