Profit’s role in the economy

As the economy has improved, business profits have risen. But is this good or bad? North Carolina State University economist Mike Walden responds.

“Profits are very volatile in the business cycle. They tend to go down – in fact, businesses lose profits and lose money – when we’re in a recession. They tend to go up when we’re doing well. And, of course, the economy has gone better, so we’ve seen a rise in profits.

“I think what most people forget about profits, however, is that they are very essential to the economy. They’re really are a signal to the business world as to where they put their resources.

“Let me use a really simple example: Let’s say the price of rakes goes up, and businesses are making more profits from selling rakes. For some reason people want to buy rakes. What we want to have happen, however, is for the manufacturers of rakes to make more rakes. Well, will they? Well, yes, they will, because they initially see more profit in it. So they are going to shift their resources away from maybe making brooms, and they’re going to sell rakes. And they are going to eventually supply more rakes to the retailers. When that happens, the price of rakes will go down, and so will the profits.

“So, in that very simple example, the rise in profits initially is this signal that says, ‘Hey, people want more rakes, make more rakes – and people and businesses eventually do.”