ECON103: Principles of Austrian Economics I

Profits    = income > expenditure

Losses    = income < expenditure

• Entrepreneurs speculate on production processes being profitable, and employ the factors of production (labor, capital, and land) to them. They incur the upfront costs and collect the revenues.
• The future is uncertain, and the profitability of a business cannot be determined beforehand. Entrepreneurs speculate on it and employ their resources based on it. Only by guessing better than others can profits be made.
• If entrepreneurs speculate correctly, they collect profits, allowing them to control more capital. If they speculate incorrectly, they make losses and lose capital.
• Capitalism is skin in the game. Incentive compatible. Capital is entrusted only to people who would lose it if they mismanage it, and stand to lose more individually than society as a whole from mismanaging it.
• Capitalism ensures capital remains productive by ensuring it is constantly going from the less productive to the most productive.
• Capitalism is an entrepreneurial system, not a managerial system. The economic problem is an entrepreneurial problem, and not a managerial problem.
• Capitalists seeking profit allocate capital to different methods of production in capital markets.
• The original function of capital markets is the allocation of capital, and financial instruments are ultimately tools for the efficient allocation of capital resources to their most productive uses. Today capital markets mostly function as a way to gamble on pronouncements of central bankers.
• Entrepreneurial investment comes from capital accumulation, and that is determined by time preference.

The effects of entrepreneurial investment:

1. Higher productivity
2. Longer processes of production: Investment allows the investment in longer processes of production, which allow for higher productivity (fishing rod, net, boat, etc...). Will allow for more products, as well as new products. Variation-selection of methods of production ensures only the more productive longer processes survive.
3. Lower interest rates
4. Short-term profits for the entrepreneurs, likely to disappear as other investors enter the market, and starting bidding up the price of the factors of production
5. Higher real wages but (probably) lower nominal wages: Capitalism does not make more money, it makes more goods and services. Wealth and abundance is reflected in dropping prices and wages.
6. Higher real rents, although some rents might drop (because land is immovable, and so it's a specific factor), but lower nominal rents are likely

• Increased investment benefits landowners and laborers by giving them higher wages and rents. But it harms capitalists by giving them lower interest rates. Capitalists also incur the risk of loss of their capital. And if they do make a profit, it is likely only a short-term profit as others copy them. Entrepreneurship is not fun and games.
• Investment leads to an increase in the stock of capital, which leads to rising worker productivity. Workers benefit from all capital accumulation, as their productivity rises and their output increases. As they can move to other employees, their wages will rise to match their marginal productivity (See lecture 7).
• Capitalists do not necessarily benefit from capital accumulation. There is always a risk of loss. And if there is a profit, the market will soon start to eat it away. The higher profits will inevitably accrue to the workers and landowners, whose wages and rents will continue to rise to match their productivity. E
• Entrepreneurs may or may not benefit from capital accumulation, while workers always benefit from it.
• Entrepreneurship involves far more uncertainty than labor. It is entirely understandable that a large number of people prefer labor to entrepreneurship. It can be very rewarding, and involves far less risk.
• The effect of net investment is lower interest rates and higher real wages and rents. (Nominal wages and rents can actually decline, but in real terms they must rise with a rise in net investment.) Some rents may rise while others drop, but all wages rise.
• The main benefits gained by the investors, therefore, are short-run entrepreneurial profits. ... Aftera while, the profits tend to disappear as more investors enter this field, although changing data are always presenting new profit opportunities to enterprising investors.
• The pure rate of interest, then, can change at any time and is determined by time preferences. If it is lowered, the stock of invested capital will increase; if it is raised, the stock of invested capital will fall.
• In the real world, of course, nothing is absolutely certain, and therefore the pure rate of interest (the result of time preference) can never appear alone.
• Profit and loss are the results of entrepreneurial uncertainty. Actuarial risk is converted into a cost of business operation and is not responsible for profits or losses except in so far as the actuarial estimates are erroneous.