Imagine you live in a rather backward place, where artisans and craftsmen co-exist with modern manufacturing.
And you are poor, although otherwise you are a modern gogetter: enterprising, hardworking, smart, realist and disciplined. As importantly, you are qualified as a tailor and own your sewing machine, inherited from your grandfather.
So, you decide to start a small business requiring little capital: you want to make shirts for sale.
You could be living nowadays in Bangladesh, for all we know, but people in the European Middle-Ages used to operate in similar ways.
You figure it takes you, as it does everybody else, one day to make a shirt, and it costs you to produce it:
|Material unit cost (i.e. per shirt)|
Should you ask Re 75 for your shirts? Obviously, not!
You are spending one day working on that shirt, but this cost is not reflected in the price. So, you put on your "worker" hat and charge the standard wage paid in the industry (say, Re 65 a day). With that, the shirt price raises to Re 140.
Is this the "right" price? Putting on your "capitalist" cap, you realize it isn't quite good, yet. True, it includes the standard shirtmaker daily wage, but you could get the same amount working for a shirt factory, without going through any other troubles (risking your capital, ordering materials, book keeping, etc.)
So, you must include an amount as compensation for your role as capitalist and for the use of your capital, but how much?
Other things being equal, you'd prefer to sell each shirt at the highest possible price: the excess of the unit price over unit cost being your compensation as capitalist (i.e. your profit per shirt).
However, this is not possible in general: the more you charge, the more customers you turn to your competitors.
In practice, you do the simplest thing: charge the same as everybody else. This is smart thinking, because shirts like the ones you make sell for, say, some Re 145 (give or take a little). This leaves an average margin of Re 5 as unit profit.
Is that good enough? Strictly speaking, it depends: if you had other more profitable -but roughly equivalent- investment options, it wouldn't be. But let's assume Re 145 is a good price.
Let's pause here, to consider something: as an independent artisan, you share characteristics with workers and businesspeople; however, there are differences, if subtle.
You share with workers the need to make a living. And the money you get to make a living (your labour compensation) comes from your labour, just as it does for any other worker.
With businesspeople (or capitalists) you share the need to make profits, and, being an independent artisan, your profits are a mark-up you add on top of your costs.
And like other businesspeople (but unlike other workers), you control all aspects of production. In particular, you control how fast and how long you work (and you get the full benefits/costs of any changes you decide!).
And you are motivated and hardworking, so a little time into your shirt-making, and you find yourself able to produce 2 shirts every day, while everybody else still manages only one!
How much is your daily profit now:
A. Twice as much as before (i.e. Re 10).
B. No change.
C. None of the above?
Think about the answer and we'll check it later, in the next blog.