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Source link: http://archive.mises.org/8912/misess-profit-and-loss-available/

Mises’s Profit and Loss Available

November 7, 2008 by

In 1951, Mises gave an outstanding paper that made the summary case for the price system under capitalistic economic systems. In “Profit and Loss,” he explains how cost accounting is the critical institution that ferrets out social waste, ensures that resources are directed to their most highly valued ends, and how entrepreneurs respond to price signals. His presentation is systematic, relentless, logical, and ultimately devastating to the opponents of profit and loss.

He explains what it is that entrepreneurs confront in a market economy and how no bureaucratic institution can replicate the trial-and-error process that is at the heart of the market system. He weaves into his analysis the role of the consumer as the final arbiter of what is produced and distributed.

Behind Mises’s presentation was a burning desire to not only persuade the world but the attendees of the Mont Pelerin Society meeting in particular, whom Mises suspected were losing touch with core truths about the market order.

The great merit of this essay is its brevity and passion. It explains the workings of what most people never think about or take for granted. Graduate students economics have appreciated this essay for many years as the best summary of the technical side of the market. When it first appeared, it was as a monograph but it has been more than 50 years since it has been available in this format.


William Rader November 7, 2008 at 11:33 am

This is slightly off topic, but one of my greatest fears about the opt-repeated mantra of the Obama-Biden campaign, “Tax the rich!” is that this kind of short-sighted policy may help to stifle entrepreneurship and potential job creation over the next couple of years. This leads me to the question, “How WILL jobs be created?” By New Deal social programs? By bailing out established corporations who have been resistant to establishing new technologies? Encouraging start-up companies in the Silicon Valley that are dedicated to producing new vehicles, as well as start-up companies elsewhere in the nation that are looking to produce new forms of energy, seems like a better place to start to me. I believe that Mises and Rothbard would have agreed.

Kevin Allen November 7, 2008 at 12:28 pm

I agree with your point William – so long as you aren’t putting forth that the government should be “encouraging” or for that matter, “discouraging” anyone – whether that anyone be a legitimate new technology or an old bluechip….I think Mises and Rothbard would agree.

William Rader November 7, 2008 at 1:28 pm

Thank you, Kevin. Certainly a non-interventionist stance is always best.

P.M.Lawrence November 8, 2008 at 1:12 am

“Mises… explains how cost accounting is the critical institution that ferrets out social waste, ensures that resources are directed to their most highly valued ends, and how entrepreneurs respond to price signals”.

So, what did he have to say about transfer pricing, allocating profits and costs between different centres, and such like?

newson November 8, 2008 at 6:03 am

“As people see it today, the fiscal and budgetary objectives of taxation are of secondary importance only. The primary function of taxation is to reform social conditions according to justice. From this point of view, a tax appears as the more satisfactory the less neutral it is and the more it serves as a device for diverting production and consumption from those lines into which the unhampered market would have directed them.”

from mises’ words above, it would seem to be transfer pricing and other tax minimization schemes are a logical reaction to unfair, progressive taxation regimes.

P.M.Lawrence November 9, 2008 at 12:13 am

Newson, you misunderstand transfer pricing. You are addressing how firms choose their transfer prices (between subsidiaries or departments or whatever) in the presence of a tax regime. Nevertheless, regardless of taxes, any firm that is compartmentalised inherently moves goods and services around internally. These have to be “priced” despite not being market transactions; there is nothing in accounting to offer any guidance on how to set these transfer prices. Either the firm has to do some sort of mark to market, based on the nearest equivalent outside prices, or adopt some framework of its own.

But that comes down to the calculation problem, occurring within a larger firm. I was asking what Mises had to say on the area, since accounting is silent on the point. What he thought solved firms’ internal information problems – doesn’t.

newson November 9, 2008 at 6:42 am

to pm lawrence:
i’m sure mises didn’t address what you seem to be referring to, ie internal accounting, because it’s obvious that intercompany allocation of costs is arrived at after haggling between the ceo/owner and divisional heads. the apportionment of cost is entirely discretional, and mises not being a management consultant, would have sensibly said nothing.

fundamentalist November 9, 2008 at 11:19 am

I agree with Newson. I haven’t read anything from Mises about transfer pricing. I wonder why PM Lawrence thinks it’s important. The market price is the only important price.

P.M.Lawrence November 9, 2008 at 6:26 pm

It’s important because leaving it out leaves out the calculation problem. That “haggling” – within the firm – is not a market process but an internal political one. Basically, unless there is an approach to internal/transfer pricing that “ferrets out social waste [and] ensures that resources are directed to their most highly valued ends”, those things don’t happen. Cost accounting, on its own, simply does not do it. Of course it is sensible to leave it out – but it is not sensible to claim that cost accounting does the job he claimed it did. It’s a necessary part, but not the answer.

newson November 10, 2008 at 2:18 am

to pm lawrence:
“haggling” is the process, how could it possibly not be so when the owner is one? when transactions are made between associated public companies, both independent valuations from disinterested third-parties (accountants, geologists, engineers etc.) and the two boards of directors must sign off the transaction (opening themselves to the risk of shareholder litigation if the value doesn’t please some bloc). common directors may be barred from voting the transaction. the listing rules have all sorts of rules governing this, a political decision.

P.M.Lawrence November 10, 2008 at 3:05 am

Newson, that’s a red herring. Leaving aside all the issues associated with internal politics, like agency costs, the fact remains that – even under your scenario – other stuff has to be brought in. Cost accounting is not sufficient to sort out the calculation problem within the firm. The problem even comes up as between departments within a firm that is a single entity.

newson November 10, 2008 at 8:08 am

to pm lawrence:
and that is precisely why conglomerates are often prize targets for raiders. more often than not the internal inefficiencies cannot be overcome under the one roof, for cost accounting is only objective when their is no common ownership.
i don’t think mises would have anything to say about what happens if i sell my car to a family member for a nominal value. the sale would have to be at arms length in order for it to be a genuine price discovery process.

fundamentalist November 10, 2008 at 8:22 am

Transfer pricing is done for political or tax reasons but have little effect on the market price for the final good. They’re subjective valuations of internal processes. The manufacturer still has to base his final price in the market on the objective factors of the demand, competitor prices, and his own total costs. That’s why transfer pricing is an accounting issue but not an economic one.

P.M.Lawrence November 10, 2008 at 6:45 pm

“Transfer pricing is done for political or tax reasons but have little effect on the market price for the final good”.

The first part is wrong. The last part is right for direct effects but not for second order stuff that comes from the first part.

Transfer pricing is done because you have to set some pricing when goods and services go from one part of a business to another. Which numbers are chosen for those prices are indeed usually chosen “for political or tax reasons” these days, but some numbers have to be picked regardless of such incentives.

When that internal economy is profit or loss making it shows up eventually, somewhere in the system. That’s not a direct effect based on market prices of inputs or final goods and services connecting outside the firm. Imagine if the firm made all its own pencils from materials found in their own land, using graduate trainee labour “because we have to pay them anyway”. There are all sorts of dubious bases and foregone alternative uses hidden in reasoning like that.

Accountancy March 1, 2011 at 11:42 am

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Chuck Royea April 14, 2011 at 2:31 pm

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