§1. _Profits and Earnings of Management_. The profits of a business, as they are ordinarily reckoned, whether for the purposes of income tax or of a balance sheet, comprise several elements which are fundamentally distinct. The relative importance of these various elements varies greatly from one type of business to another. The profits of a private business include, for instance, the remuneration of the work of management, which in the case of a Joint Stock Company is mostly paid for by salaries or directors' fees. It is to their profit that farmers, small shopkeepers, and the partners of a private firm look not merely for a return upon their capital, but for the reward of their own labors. "Earnings of Management," as they are usually termed (though in truth they often cover other and humbler forms of labor) are thus frequently one of the ingredients of profits. §2. _The Payment for Risk-bearing_. There is another element of great importance about which our ordinary ideas are apt to be so vague that it will be well to devote a chapter to its examination. This is the element of payment for risk, or rather the reward of risk-bearing. Risk is inherent in all business, as it is inherent in all life. The vagaries of nature and the vagaries of man are alike responsible. The farmer may find his harvest ruined by a drought or by a deluge; the coal or the gold, for the extraction of which you have perhaps set up an extensive mining plant, may come to an end which is unexpectedly abrupt. You may put your money into roller-skating rinks and find that cinemas have become the rage with the fickle public; sometimes "the market" may decline for causes which remain obscure but with consequences which are disagreeably plain. But while risk is always present in some degree, the degree varies enormously from one industry to another. Now, it is obvious enough that in an exceptionally risky industry, where there is a considerable possibility that the capital invested will yield no return at all, the profits of those concerns which succeed are likely to exceed the rate of interest on gilt-edged securities. But what is likely to be the magnitude of this excess? Is risk-taking rewarded if there is any such excess, however small? Or will it suffice that the gains and losses should average out to a fair rate of interest over the whole industry? To enable us to think closely let us suppose for a moment that we can measure accurately what the chances are.