salaried executives, and their salaries are deducted as a cost before profits are computed. Consequently, such salaries do not figure even as part of gross profits. But the management is by no means entirely in the hands of the executives. Some part of it is distributed among stockholders, especially the large holders or the "insiders," the board of directors who may or may not be stockholders, and the bankers who exercise a supervisory influence by virtue of their right to scrutinize the security behind their loans. Thus, imputed wages of corporate management, although clear as a theoretical concept, are exceedingly difficult to calculate as a concrete thing. Finally, the risk factor in profit, or the pure profit element, is a complex matter. The risk settles largely upon those who have capital actually invested. But the ability of the hired management in shouldering these risks is more vital by far than any ability displayed by the stockholders en masse. The risk factor, although distinct as a theoretical concept, is hard to measure in actual corporation finance. The three elements in gross profits are definite theoretical notions but highly elusive statistically.

Profit Viewed as a Residual Share. From the viewpoint of the individual business, profits are a left over share after all other shares have been paid. The business man pays labor, capital and land charges, and after such costs have been deducted from income, if there is anything left, the residue is considered as profit. Consequently, the profit is often termed the "residual" share.

Because profit is residual, it is likely to fluctuate more than other shares in production. A certain minimum of interest, wage, and rent costs must be paid by the business man, even though his income has fallen off sharply. Instead of making a profit, he often suffers a loss. His profit then is negative. His residual share is extinguished. Business men are unwilling to undertake this risk of loss, unless they see ahead the hope of gain and profit.

Profit Under Conditions of Static Equilibrium.-The central doctrine of economic theory as to this problem has long been that the residual share in distribution tends to disappear altogether. We may state the conclusion of the theory before we state the specific reasons for the conclusion. The primary conclusion is that competition, to the extent that it is free and unrestricted, tends to wipe out pure profit entirely, and to reduce it to zero. To state the same conclusion conversely, pure profit exists only in so far as there is imperfect competition and delay in the working out of the forces of competition.

The reasoning behind this conclusion involves certain hypothetical assumptions. To begin with, we may postulate an economic condition of "normal equilibrium." This condition rests upon two main characteristics. First, it is characterized by perfect competition. Second, it is characterized by a changeless set of economic forces. In an economic state where there would be no change, there would be no alteration in population, no price fluctuations, no changes in people's wants, no inventions or novelties, no climatic variations, no introduction of new

supplies of land, labor, or capital. In this imaginary state, there would occur the wearing out of old capital but it would be steadily replaced by a proportionate amount of new capital. There would occur the death of the older generation, but such loss would be steadily replaced by proportionate numbers of the incoming generation. There would occur the consumption of old goods, but such consumption would be steadily replaced by a proportionate production of new goods. Exact proportioning of the different factors in production, steady balancing of consumption and production, perfect competition among all factors, normal equilibrium of all price relationships,-these are the outstanding features of the purely fictitious and hypothetical "static state."

In such an imaginary state, what would be the relation between costs and selling prices? Upon the answer to this question hinges the final doctrine that profit tends to disappear altogether. The essence of the relation is that selling prices tend barely to cover costs of production. Consequently, there tends to be no profit margin left between the two. To put the same idea in other words, where there is no change and perfect competition, market price is the same as normal price. It will be recalled that normal price is the price which approximates the cost of production. At the same time, differences in costs of production between various business men will tend to be ironed out. If any one producer cuts his costs by any means, other producers will follow his example and cut their costs accordingly. With costs to the bulk of producers approximately even, and prices falling to the level of costs, profit margins are squeezed out of existence. The normal rate of pure profit, therefore, tends to be zero.

If prices were to rise above the normal or cost level, immediately business men would plunge into those particular lines of production, put additional supplies of goods on the market, and thus force prices down to the cost level again. Competitors are always watching for such an opportunity. If they should see the least spread of prices above costs, they would immediately hammer prices down again to the cost level. Any margin of pure profit is a golden bone upon which the dogs of competition pounce with ravenous appetite. In the state of normal equilibrium, the prices which prevail are the normal or cost prices, and the profits which prevail are the normal or zero profits. There would be no pure profit in the static state.

Having seen the forces at work in the purely static state, we may complicate the situation by superimposing upon the static state the actual conditions which prevail in the business world. We move from the world of hypothesis and assumption to the world of reality. We move from the static state to the dynamic state. And in the dynamic or realistic state, we find two dominant characteristics which differentiate it from the static state. These two characteristics are, first, imperfect competition; second, constant change. In brief, the two things which we eliminated utterly from mind in postulating the state of normal. equilibrium, we now add to the picture. In the world of active business

which we see all around us, we observe the universal presence of the twin facts of restricted competition and of unrestricted change.

The forces which restrict competition are legion. Chief among them we may mention monopoly, government regulation, business coöperation and association, and joint agreements and understandings. The forces which underlie unrestricted change are likewise legion. Certain of the chief of these may be enumerated: (a) Fluctuations of population; (b) Rise and fall of individual prices; (c) Rise and fall of average prices, i.e., of the value of money; (d) Inventions, scientific discoveries, and improved methods of production; (e) Introduction of new goods for consumption; (f) Variations in climatic and seasonal conditions; (g) Exhaustion of old or discovery of new natural resources; (h) Changes in the wants, tastes, and fashions of consumers; (i) Changes in the efficiency of labor and management; (j) Changes in the proportions which wages, rents, and interest costs bear to the total costs of production.

In this dynamic state, market prices deviate from normal prices. This deviation is the cause of pure profit in the actual world of business. In the midst of change and fluctuation, certain business men find ways and means to cut their costs below the average level. They sell, however, at the high level set by high cost producers. Consequently they enjoy a margin between cost and selling price. This is the pure profit margin. It is born of change, fluctuation, variation, discovery, invention, and progress. But why is it not at once devoured by competition and wiped out of existence, as in the case of the static state? Precisely because competition is imperfect and enfeebled in the world of reality and change. Surrounded with restrictions, interwoven with monopoly, regulated by government, eliminated by business consolidation and coöperation, competition emerges from the dynamic picture a battered and bruised weapon. Stripped of its great vitality, competition cannot promptly hammer market prices down to the cost level. It cannot make actual prices coincide with normal prices. It cannot wipe out the pure profit margin. It cannot reduce pure profit to zero.

But this is not the end of the reasoning. Competition is by no means out of the running, even in the dynamic state. It takes on new forms, utilizes new practices, carries on with new methods. And just because it is present, no matter in how imperfect or varied a form, it persists in asserting its influence in unmistakable terms. Competition establishes a "tendency" for profit to be extinguished in the dynamic state. This tendency moves in the direction of the static state of normal equilibrium. It moves, but never arrives. In the long run it tends to reduce pure profit to zero. In the short run, changes occur which upset the even forces of the static assumption. Competition is frustrated in carrying through the tendency to annihilate pure profit, by the forces of change from without and by the imperfections and restriction of competition from within. The tendency, therefore, for this imperfect competition to extinguish pure profit is always present and

always an important force in the business world. The delays and obstacles in the working out of the tendency are multitudinous. What would be true in the long run may never be attained, because in the meantime new changes thrust themselves into the arena and new restrictions upon competition come forward. And yet in the midst of all such delays, interwoven with all fluctuations and changes, omnipresent in all the realities of the dynamic state, the tendency of competition to drive market prices down to normal or cost levels and to depress pure profit to the zero point asserts itself tenaciously, inescapably, irrepressibly. It is this fact which classical economic theory emphasizes. It is this fact which business men encounter in the everyday struggle to prevent prices from falling to the point of costs. It is this fact which is brought out vividly by the assumptions of the static state, and by the realities of the dynamic analysis.

To summarize, profit originates in constant change and imperfect competition. It tends to be reduced to the vanishing point under the influence of competition, however imperfect. But under this tendency, it is not actually extinguished, partly because of new changes which constantly intervene, and partly because of the ever-present restrictions upon perfect competition itself.

Profit as Related to Risk and Ability.-Profit has often been considered as a remuneration for risk. Risk is inherent in the perpetual change and fluctuation which characterize the real business world. Any one who undertakes the management and direction of a business must shoulder the risks involved. But he will be willing to do so only under the condition that he expects to be able to secure a suitable reward. This reward, according to this explanation, is pure economic profit.

In criticism of such a theory, we find it obvious that profit bears some relation to risk, but the precise nature of this relation is not made clear by stating that profit is remuneration for risk. It would be more definite, perhaps, to state that profit is secured in spite of risk, not as a reward for it. The business man has no moral claim on profit as a reward for risk taking. He has no natural right to profit as a reward for risk taking. He has merely an opportunity to match his wits against the risks involved, and if he is shrewd and lucky enough, he will make a net gain. The profit is a gain, not a reward. Reward implies that a man has performed some moral act or social service, and is entitled to step up to the bar of justice and claim a reward. Profit should be separated from this whole notion of moral reward. Profit to the economist should be a question of gain in spite of the risks involved in business enterprise.

The only direct way in which risk can be considered a cause of profit is through the effect of risk upon the scarcity of able employers. The risk factor not only deters many men from entering business at all, but weeds out many of those who do enter but later fail. Risk not only scares men away from enterprise but kills out a great percentage

of those who venture to engage in it. Consequently, risk tends always to keep the number of successful risk-takers relatively scarce. Plenty of men can plunge into the responsibilities of business, but only a limited number can emerge from those responsibilities successfully. Scarcity of the ability to undertake business risks successfully enables those who do survive to gain an element of pure profit. The survivors succeed in spite of the risks involved, but the number of survivors is decidedly limited because of the severity of the risks involved. Hence, the final explanation runs in terms of scarcity of a particular factor in production, namely, of competent risk-takers. In this respect, profit comes to be explained by the same principle of scarcity as will be found applicable to the other shares in production. That is, wages are explained by the relative scarcity of the different grades of labor, interest by the relative scarcity of the different grades of savers, rent by the relative scarcity of the different grades of land. So, too, profit is explainable by the relative scarcity of the different grades of business ability in risk-taking.

As will appear later, this risk explanation of profits is not an allsufficient explanation, but in so far as risk does help to explain profits, the point here insisted upon is that profit is not a reward for risk, but a gain made possible by the scarcity of able and successful risk-takers.

The term "risk" needs further limitation for technical usage. Some kinds of risks are calculable by laws of averages and can be covered by insurance. Insurable risks and measurable risks are a cost of doing business, and are not included in the risk factor which explains profit. The risk element associated with profit is risk which is noninsurable and nonmeasurable. It is pure uncertainty. This kind of risk is the force keeping up the scarcity among successful risk-takers.

Closely interwoven with the preceding explanation of profit, is an explanation which emphasizes that profit is a reward for skill and efficiency of management. Thus Taussig remarks, "Business profits are best regarded as simply a form of wages." In the long run, those business men who persistently and consistently make a profit must do so because of superior ability and not because of pure luck. Many men can plunge in and make profit in a good year, but their gains are offset by their losses in bad years. The temporary profits of good luck are likely to be offset by the sharp losses of bad luck. In the long run, according to this view, luck profits are zero, or even a negative amount. Long run profits flow only to those captains of industry who have the rare ability to surmount the shifting tides of fortune. Profit is, therefore, a reward for rare and superior business ability.

This explanation merges readily into our view of the risk factor outlined above. Both views rest upon the scarcity of high grade ability. The scarcity of ability is in reality scarcity of the ability to shoulder business risks successfully. Ability and risk are two different aspects of the same central phenomenon. To summarize the matter in a sen1 Principles of Economics, Volume II, p. 164, 1921 edition.