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How does this actuating force, this primary incentive, exercise its control over production schedules? Fundamentally, we may say that the expectation of profit determines what kinds of goods shall be produced and how much of them shall be produced. When business men expect that they can make more profit by making more automobiles, they will make more automobiles. When they expect that they can make more profit by making more furniture and fewer automobiles they will plan production accordingly. The expectation of profit governs production schedules.

Emphasis is on expectation of profit. The expectation may fall short of realization. It may be utterly misleading. But as long as a given expectation holds, it governs production schedules. The expectation is based upon forecasts, estimates, calculations of the future. These may prove to be wrong. When they are proved to be wrong, new expectations of profit will arise, based upon new forecasts and estimates. The new and revised expectations of profit will govern new production schedules. The expectation, the anticipation, the forecast of today, govern the production program of today. The production programs will be corrected, modified, revised tomorrow, when anticipations of profit are corrected, modified, revised. Right or wrong, false or true, the prevailing anticipation of profit rules the kinds and amounts of goods that shall be produced.

The concrete effect of profit expectations upon production of goods. may be seen by studying the main variations which occur in production. Previously in this discussion, fluctuations have been classified as secular, cyclical, seasonal, irregular. The effect of profit on each of these variations may be observed.

The secular trend of production in the aggregate has been steadily upward during the last half century. Output of goods has increased at an average rate of about 2 per cent per capita annually. The volume of physical wealth has increased under the guidance of the expectation of profit. The total of commodities available for human use has expanded under the governance of the profit anticipation. A boast is often made by the staunch defenders of capitalism that private profit is superior to any other conceivable system of production control because it meets the acid test of having turned out more commodities than any other business system in human history. Proud of our unprecedented physical wealth, awed by the grandeur of our material fortune, it is easy indeed to assume that private profit is a sacred, beneficent, and glorious guiding force. From any scientific point of view, we cannot subscribe to this enthusiastic adoration of the profit motive. The most that we can do is to acknowledge the fact that profit has increased per capita wealth. Whether profit expectation will continue to do so in the future, whether it is superior to some other method of controlling production schedules, whether it is the permanent, inevitable, and best device for the purpose, is a highly controversial issue. We may leave it for later discussion. Our only concern here is to note

the historical fact that the secular trend of production has shown a marked increase under the dominance of the expectation of profit.

Moreover, profit expectation has sifted and selected between the secular trends of different kinds of production. It has, for instance, made possible swift development of such lines of production as the railroad, the automobile, the radio. It has caused a secular decline of other lines of production which have passed their prime. The secular rise and fall of industries has obeyed the dictates of the expectation of profit. The ruling hand of profit has ruthlessly contracted this line of production and has vigorously expanded that line of production. The secular increase or decrease of production has been effectually accomplished by the profit force. Profit has affected the secular trend of production in individual industries by quick stimulation of those lines which yield the hope of large profit, slow growth of those lines which yield mild profit, and decline of those lines which yield inadequate profit.

The cyclical fluctuation of production is discussed in detail in the chapter dealing with business cycles. The series of ups and downs of production characteristic of the business cycle is controlled by the profit outlook. Production in general increases and prosperity appears when business sees a bright expectation of profit. Production in general decreases and prosperity collapses and decays when business sees a dismal outlook for profit. Production cycles are ruled by profit cycles. If production this year is 10 per cent less than last year, it is because the prospect of profit has darkened. If production this year is 10 per cent above last year, it is because the prospect of profit has brightened. The profit cycle shows a much wider amplitude than the production eycle. Where the rate of earnings on capital in 1917 was around 25 per rent, in 1921 it was around 3 to 4 per cent. The rate in the former year was about eight times as great as in the latter year. On the other hand, the physical volume of production was only about one-tenth greater in the former than in the latter year. Making goods fluctuates within a much narrower radius than making money.

The relative size of fluctuations in making goods and making money varies greatly from industry to industry. No uniformity appears. No stereotyped relationship prevails. The pecuniary cycle dominates the physical cycle in unique degrees and ways in each industry. The money cycle dominates the commodities cycle to a different extent in the case of each commodity. But whatever the degree and whatever the extent, the outstanding fact demonstrated by modern statistics and by recurrent experience is that the prospect of profit controls the cyclical fluctuations of production.

Consequently, in answering our leading question, How does profit affect production? we come to the conclusion that profit fluctuations are responsible for the production fluctuations of the business cycle.

The third type of production fluctuation, namely, the seasonal, is likewise dominated by profit prospects. The majority of industries show

some form of seasonal change in production. Seasonal production to meet a seasonal market is the requirement of profit considerations. This enforced seasonal production is not, however, a fixed and inescapable condition for all industry. Many industries have found that they can, by modern methods of management, carry on year around production to meet a seasonal market. Such a change is made because, once business discovers it can be made, the new policy of continuous production promises better profits. Seasonal production remains seasonal unless and until business sees a chance for profit from making it continuous. The elimination of seasonal production takes place if, when, and where business sees a chance for profit from making the elimination. Profit expectation governs seasonal production.

The fourth type of production fluctuation, namely, the irregular, likewise follows the expectation of profit. War stimulates production because it stimulates the prospect of profit in industries which cater to the war demand. Unusual changes in the weather affect production only after it is apparent to business how they will affect profit. The abnormal, the unforeseen, the unfortunate, the extraordinary, influence production according as they influence the prospect of profit.

It is obvious, therefore, that the center of initiative and guidance in modern business is the prospect.of profit. The hope for the making of money is the decisive factor in plans for the making of goods. Pecuniary factors rule the industrial factors. Profit is the nerve center of business. The orders for more production or less production emanate from the offices where the balance sheets and the profit and loss statements are read. The secular, cyclical, seasonal, and irregular fluctuations of commodity production are the servant of profit making. The inner nature of economic life in modern society can be understood only by grasping the significance of this pecuniary sovereignty in business.

Profit and Property Valuation.-Profit not only governs the production of goods, but also governs the valuation of all forms of property. Profit holds a most important position in value theory. The direct determinant of the value of industrial, railroad, commercial, or real estate property, is the expected ability of the property to earn profit. The value of a factory hinges upon the amount of money that can be made by its operation. The acid test of valuation is its pecuniary effectiveness, and only incidentally and secondarily its mechanical efficiency. The value of a farm depends upon the size of the net returns which the land is capable of earning. Physical qualities of the property are wholly subordinate to the profit-earning qualities of the property. Tangible goods and material wealth as such give no clue to their valuation. Only the prospect of making money from the control of goods and wealth gives the clue to valuation. The valuation of property is, therefore, a monetary matter primarily, and only incidentally a physical or mechanical matter. Money profits govern valuations.

The mathematical device of ascertaining valuation is capitalizing the prospective net earnings of the property. The calculation involves two

variables, the size of the earnings and the rate of capitalization. Thus, earnings of $100,000 capitalized at 10 per cent would give a valuation of $1,000,000. If the earnings be doubled, and are $200,000, the rate remaining the same, the valuation would be doubled, and would be $2,000,000. An increase of $100,000 in earnings would bring an increase of $1,000,000 in the valuation of the property. On the other hand, if the rate of capitalization be cut in half, and be made 5 per cent, the size of earnings remaining the same, the valuation would be doubled, and would be $2,000,000. In this case, without any change in earnings, but merely by a change in the rate of capitalization, the value of the property would be doubled. A drop in the rate of 5 per cent brings a change in value of $1,000,000. The valuation is the result of the two variables, earnings and rates. A rise in valuation may come either from a rise in earnings, or a fall in the rate of interest, or a combination of both. Earnings remaining the same, the value of property tends to be greatest when the rate of interest used as the basis of capitalization is lowest. Rates remaining the same, the value of property tends to be greatest when earnings are highest.

These relationships are perhaps best seen in the values placed upon corporate securities in the stock markets. These securities are evidences of corporate properties, tangible or intangible, and the prices paid for the securities are simply values of the rights to share in future income of the corporations. The thing bought fundamentally is rights to share in expected corporate profits. A share of stock which entitles the holder to share in such profits as are made derives its value primarily from capitalizing the prospective income. Prices of such stocks rise highest when the anticipation of earnings is highest, and when simultaneously the rate of interest is lowest. Prices of such stocks fall most sharply when anticipation of earnings is darkest and when simultaneously the rate of interest is highest. The foundation of a bull market on the stock exchanges is a combination of high prospect of profits and low rates of interest. Conversely, the foundation of a bear market is a combination of low prospect of profits and high rates of interest. Prices and values reflect earnings and rates.3

In applying the principle of capitalization of prospective profits, many related factors have to be taken into account. It is not a simple formula which can be used indiscriminately, automatically, or mechanically. A mathematician can complete the purely arithmetical computation quickly, but his computation would be utterly misleading if that were all of the process. "Prospect of profit" is an unknown quantity. It can be estimated only by shrewd judges of the market. It can be guessed at only by competent forecasters of business conditions. Here

3 In strict economic word usage, earnings should be separated into reward for risk taking, or profits; reward for saving, or interest; and reward for management, or wages of management. This separation is made in the chapter dealing with Capital and Interest. For present purposes, however, it is less confusing to use as a thinking tool the general concept of business profit as it is understood by the accountants, the speculators, the brokers, and the property market generally.

is room for endless difference of opinion, for endless conflict in business judgment. Likewise, the rates of interest and capitalization are the rates of the future. They too can be estimated and guessed. They offer room for opinion and judgment. But the calculation looks to the future. Whether we take earnings or rates, we are obliged to look to the future. Present earnings and rates are involved, but more vitally involved are the earnings and rates of the future.

Future calculations are affected by a vast array of factors. Irregularity of the prospective earnings, dividend histories, safety of principal, marketability, depreciation, personnel of management, liens and encumbrances, inventions and patents, franchises and contracts, all of these are involved in estimating future rates and earnings. The essential fact here emphasized is that all such related factors are significant in the value process only in so far as they affect earning power. All factors tie up to this pivotal factor of capitalizing profits before they have a bearing upon valuation. Consequently, the appraisal of property values becomes a highly technical undertaking, involving a right understanding of how each and all of these sundry factors help or hinder the profit making power of a given piece of property. Value making involves all factors which relate to profit making. What the physical commodities are worth depends upon how much money they will make for their owners. Things take their values from the dollars that can be made by possessing them.

Under these circumstances, wide changes occur in the values of things without any corresponding changes in the things themselves.* Farm land may rise and fall billions of dollars in value without any change in acreage; corporate securities on the stock exchange may rise and fall billions of dollars without any change in the physical plant of the corporations; the national wealth may rise and fall scores of billions of dollars without any change in material resources. The

4 There is nothing in the present explanation which cannot be fitted into the traditional analysis of derived utility and derived value. The author has no criticism of the soundness of the traditional utility analysis, but finds that it leaves the matter in a state of vagueness and indefiniteness. In order to penetrate the phenomena of modern property markets, it seems necessary to go beyond the utility methods of analyzing value. It seems necessary to go directly to the heart of the pecuniary or business process of valuation. When this approach is taken, the emphasis falls upon the prospective profits and the rate of capitalization.

5 The value fluctuations here in question are such as might occur under conditions where the price level would be practically stationary. That is, they are not due to inflation or deflation of the price level, but to increase or decrease of the profit scale. In actual practice, of course, changes in the measuring stick of value, due to inflation and deflation, complicate the process of capitalizing prospective profits. They complicate the process, but do not alter or check it. For instance, in the weeks immediately following the presidential election of 1924, the bright prospect of rising corporate profits and continued low interest rates led to an estimated increase in the market value of all securities listed on the stock exchange of more than $3,000,000,000. The physical plant of the corporations represented was practically unchanged, but the values of their securities were enormously changed. A mild increase in the price level simultaneously simply fortified the more strongly the belief in future rise of profits.

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