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August 2011

The Price System, Part 2: Profits & Losses

What is the social function of profits and losses? As Prof. Daniel J. Smith of Troy University describes, they provide an incentive for people to follow the information provided by the price system. By pursing profits and avoiding losses, producers and consumers use scarce resources in effective ways. In anticipation of being rewarded with profit, people and businesses are encouraged to undertake activity that will create valuable outputs. At the same time, the potential for losses encourages them to avoid excessive risks and wasteful activity. Policies that reduce profits, such as taxation, or reduce losses, such as bailouts, disrupt this function of prices and lead to inefficient uses of resources.

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