Are Profits Purely Random?

An old economist joke goes like this. A person is walking along and says to an economist, look, there is a $20 bill on the sidewalk. The economist disputes it without looking, on grounds that if it were there, someone else would have already picked it up.








The essence of profit


Profit emerges once an entrepreneur discovers that the prices of certain factors are undervalued relative to the potential value of the products that these factors, once employed, could produce. By recognizing the discrepancy and doing something about it, an entrepreneur removes the discrepancy, i.e., eliminates the potential for a further profit. According to Murray N. Rothbard,


Every entrepreneur, therefore, invests in a process because he expects to make a profit, i.e., because he believes that the market has underpriced and undercapitalized the factors in relation to their future rents.[3]


The recognition of the existence of potential profits means that an entrepreneur had particular knowledge that other people didn't have. Having this unique knowledge means that profits are not the outcome of random events, as the EMH suggests. For an entrepreneur to make profits, he must engage in planning and anticipate consumer preferences. Consequently, those entrepreneurs who excel in their forecasting of consumers' future preferences will make profits.


Planning and research never guarantee that profit will be secured. Various unforeseen events can upset entrepreneurial forecasts. Errors, which lead to losses in the market economy, are an essential part of the navigational tools that direct the process of allocation of resources in an uncertain environment in line with what consumers' dictate.


Uncertainty is part of the human environment, and it forces individuals to adopt active positions, rather than resign to passivity, as implied by the EMH. The EMH framework views the act of investment as no different from casino gambling. In the words of Ludwig von Mises, however,


A popular fallacy considers entrepreneurial profit a reward for risk taking. It looks upon the entrepreneur as a gambler who invests in a lottery after having weighed the favorable chances of winning a prize against the unfavorable chances of losing his stake. This opinion manifests itself most clearly in the description of stock exchange transactions as a sort of gambling.


Mises then suggests,


Every word in this reasoning is false. The owner of capital does not choose between more risky, less risky, and safe investments. He is forced, by the very operation of the market economy, to invest his funds in such a way as to supply the most urgent needs of the consumers to the best possible extent.


A capitalist never chooses that investment in which, according to his understanding of the future, the danger of losing his input is smallest. He chooses that investment in which he expects to make the highest possible profits.[4]


The EMH framework presents the stock market as a gambling place, which is detached from the real world. However, as Mises suggests,


The success or failure of the investment in preferred stock, bonds, debentures, mortgages, and other loans depends ultimately also on the same factors that determine success or failure of the venture capital invested. There is no such thing as independence of the vicissitudes of the market.[5]


Further to this,


Stock speculation cannot undo past action and cannot change anything with regard to the limited convertibility of capital goods already in existence. What it can do is to prevent additional investment in branches and enterprises in which, according to the opinion of the speculators, it would be misplaced. It points the specific way for a tendency prevailing in the market economy, to expand profitable production ventures and to restrict the unprofitable. In this sense the stock exchange becomes simply the focal point of the market economy, the ultimate device to make the anticipated demand of the consumers supreme in the conduct of business.[6]





More information, please read articule : http://www.mises.org/story/2641


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Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. He is chief economist of Man Financial, Australia. Send him mail and see his outstanding Mises.org Daily Articles Archive. Comment on the blog.

Are Profits Purely Random?
No. Profits are not random. There is serial correlation in profits (that is good companies usually continue to make profits, good fund managers continue to make good money) whereas there are some people and companies that do seem to follow a randomness.





I will follow with a statistics joke (amended to make it shorter)





A statistician walks into a bar with his friend to play darts. The statistician throws his first dart and it hits the wall to the left of the board by exactly two feet. The second throw is to the right of the board by exactly two feet. The statistician looks at his friend and says "bullseye!".