[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

has increased demand. Or perhaps troubles in the Middle East have decreased
supply. In either case, the higher price signals consumers to reduce their purchases
of oil products. If the price of home heating oil rises, that increase signals oil refineries
to produce more heating oil. Prices provide the information that individuals and
firms need to make rational decisions.
For the profit motive to be effective, there must be private property, with its
attendant property rights. Under a system of private property, firms and individuals
are able to own and use (or sell if they choose) factories, land, and buildings.
Without private property, firms would not have an incentive to invest in new
factories or new technologies, hire employees, produce goods and services that
consumers want to buy, and earn profits. Even if the profits to be earned from
building a new factory are huge, no firm will begin construction without the confidence
that the factory cannot just be taken away. Firms need to be able to keep
at least some of their profits to use as they see fit. Similarly, households need to be
able to keep at least some of the return on their investments. (The return on their
investment is simply what they receive back in excess of what they invested.)
Property rights include both the right of the owner to use property as she sees fit
and the right to sell it.
These two attributes of property rights give individuals the incentive to use
property under their control efficiently. The owner of a piece of land tries to figure
out the most profitable use of the land—for example, whether to build a store or
a restaurant. If he makes a mistake and opens a restaurant when he should have
opened a store, he bears the consequences: the loss in income. The profits he earns
if he makes the right decisions—and the losses he bears if he makes the wrong
ones—give him an incentive to think carefully about the decision and do the requisite
research. The owner of a store tries to make sure that her customers get
the kind of merchandise and the quality of service they want. She has an incentive
to establish a good reputation, which will enable her to do more business and
earn more profits.
The store owner will also want to maintain her property—not just the land
but also the store—because doing so will enable her to get a better price when the
time comes to sell her business to someone else. Similarly, the owner of a house
has an incentive to maintain his property, so that he can sell it for more when
he wishes to move. Again, the profit motive combines with private property to
provide incentives.
Wrap-Up
HOW THE PROFIT MOTIVE
DRIVES THE MARKET SYSTEM
In market economies, incentives are supplied to individuals and firms by prices,
profits, and property rights.
30 ∂ CHAPTER 2 THINKING LIKE AN ECONOMIST