We now take a further step toward reality by introducing the most important person within the framework of a free economy: the entrepreneur.
His functions are manifold; we note only the most important at this point:
(1) The entrepreneur is a sort of exchange center. He intercedes in all the exchange activities which we have described so far in our simplified models.
In our isolated single-producer economic model, the worker exchanged his work-hours with nature against the proceeds of his work, the finished products. In the case of a two-producer economy these goods were then exchanged, at least partly, between the workers. A schematic view of this exchange is pictured in Figure 5.
In the real world the workers generally do not exchange their services directly with nature or with other workers. The entrepreneurs intercede in both exchange activities. Our model of an economy of two producers becomes one of an economy of two workers and two entrepreneurs, as schematized in Figures 6a and 6b. In Figure 6a the workers first exchange directly with nature. Entrepreneur A then receives the products of the work of worker A and exchanges them with entrepreneur B for the products of worker B. Entrepreneur B delivers products of worker A to worker B in payment for worker B's products, whereas entrepreneur A delivers products of worker B to worker A in payment for worker A's products. In Figure 6b the entrepreneurs have also taken over the workers' exchange with nature. The workers deliver to the entrepreneurs not their products but their work, and it is the entrepreneurs who exchange the workers' work with nature.
Each worker, as before, receives for his work the products of the other worker. (Neither model is, as yet, complicated by the existence of money; we are still in a barter economy.)
(2) The entrepreneur is furthermore the beneficiary of production cost differentials. We have assumed above (p. 12) that workers, for various reasons, produce with varying degrees of productivity. To produce the same amount of goods some need a greater, some a smaller, number of work-hours: or, what comes to the same thing, some produce greater and some smaller amounts of goods in the same time. In the real world the greater productivity of the work done is not generally due to some special quality of the worker, but of the enterprise in which he works. It is therefore not the worker but the entrepreneur who reaps the benefits of the higher productivity.
Let Figure 7 represent the hourly output of two workers. Suppose worker A produces 50 pears an hour while worker B produces 80 pears in the same time. Rectangle I then represents worker A's output per hour, that is 50 pears. Rectangle I and rectangle II together represent worker B's output per hour, that is 80 pears. If it were the difference in the workers' efficiency which leads to the differential of 30 pears, the wage of worker A would have to be 50 pears, and that of worker B 80 pears.
But if not worker B but the enterprise B in which he works is responsible for the higher output per hour, the owner of this enterprise, entrepreneur B, has no reason to pay his workers more than they would produce and receive if they were working in an enterprise of lower productivity—say in enterprise A, where 50 pears are produced in an hour. The surplus hourly production of 30 pears, represented in our graph by rectangle II, entrepreneur B will keep as a reward for the greater productivity of his enterprise. All workers receive a uniform wage of 50 pears, regardless of the productivity of the enterprise by which they are employed. This is what actually happens in reality. Uniform wage rates are, in principle, paid for the same work.
(3) We have defined profits as income that accrues to some individuals because others do not receive the whole output of their work in special circumstances of a temporary nature. The entrepreneur who keeps as income for himself the additional output of his workers which is due to the higher productivity, not of the workers but of his enterprise, is the profit-maker par excellence.
(4) The entrepreneur, however, is also the profit destroyer par excellence. If entrepreneur A sees that entrepreneur B can produce pears at lower cost than he can, he will try—and in the long run he will generally succeed in the attempt—to imitate his competitor's methods of production. As a result entrepreneur A, too, will be able to produce 80 pears an hour. The output curve of enterprise A in Figure 7 will rise to the level of enterprise B. Entrepreneur A, too, will make a profit.
This, however, will not be the end of the story. Under the assumption of free competition A, as well as B, will begin to bid up wages so as to attract workers because any increase in production would enlarge their total profits. The competition for workers will clearly go on until profits are swallowed up by wage increases. Workers will then receive not 50 pears an hour but their whole output, 80 pears an hour. The whole hourly product of labor (rectangle I plus rectangle II) will be paid out as wages. This situation will change only if and when some entrepreneurs succeed in raising the productivity of their enterprises once more.
In a stationary economy, a theoretical model of an economy which goes on each day as it did before, by definition productivity does not change. There can, therefore, be no entrepreneurial profits.