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February 4, 1943

Honorable James F. Byrnes
Director of Economic Stabilization


Prentiss M. Brown
Price Administrator


Subject; Reduction of Prices and Profits
Section 2 (a) of the Emergency Price Control Act of 1942
provides that maximum prices must be generally fair and equitable and
that they shall effectuate the purposes of the Act. Among the purposes of
the Act is the elimination and prevention of profiteering. The Amendment
of October 2, 1942 empowers the President to provide for making adjustments with respect to prices to correct gross inequities. In Executive
Order 9250, dated October 3> 1942, the President delegated this power to
the Price Administrator.

The Executive Order further directed the

Administrator in fixing, reducing or increasing piices to determing ceilings
in such manner that profits are prevented which in his judgment are
unreasonable or exorbitant.
There are certain difficulties inherent in any attempt to achieve
control ofprofits by fixing prices. Maximum prices under price ceilings
are set on ft product basis. Profits, however, are realized on a company
basis. A single company may produce several products. It is frequently
impossible, therefore, so to adjust product prices as to control company

In fixing the ceiling for any product, moreover, a single

maximum or a series of maxima may be established.

In either

- 2 -

case the ceiling will be set at a level which is calculated to be
generally fair and equitable, but the profits realized by the
several producers who sell under such a ceiling may v&ry.

It is

impracticable, therefore, to attempt completely to eliminate
unreasonable or

exorbitant profits through the employment of existing

techniques of pricing.

In large part, however, such profits can be

prevented thro gh price action and through the renegotiation of
contracts or they may be recovered through taxation.
The Executive Order clearly imposes upon the Office of Price
Administration an affirmative obi buttion. Whenever the Office fixes,
reduces or increases the maximum price of any product, it must set
it at a 1*T«1 that is calculated to prevent firms producing the major
part of the output from realizing profits that are unreasonable or
The Office he.s always tel:en profits into account in determining the fairness and equity of the levels at which maximum prices have
initially been established, in determiningffht&JierW l i — prices will
bs increased as costs rise, and in determining how large an increase
will be granted. The changes in prices and profits: that have occurred
since the initiation of price control have been so preet, however, and
the variation in the movement of prices and profits between industries
has been so large that it does not now appear to be practicable to
employ the profit standard that has been used for those purposes in
determining whether profits are to be deemed unreasonable or exorbitant.
It is possible for the Office to maintain a lower standard in
refusing or granting increases in maximum prices than it can apply in

-3 defining unreasonableness or exorbitance. It is undesirable, on the other
hand, to raise the level employed in the former case to the point which
it is practicable to establish in the latter case. The Office has
therefore decided to establish a double standard of profits, with a
lover level to be retained in determining whether prices will be raised,
and If so how far, and a higher level for determining whether profits
are unreasonable or exorbitant.
if profits

It If proposed to say, in effect, that

are above the lowsr level the Office will not raise prices;

teat If they are below that level, it m?ill raise prices only to the
point which will re-establish profits at that level; but, finally, that
when profit a rise above the hioher level, the Office rill cut prices
because such profit* are unre-:; sonable or exorbitant.
It if necet^aiy, therefore, for the Office to define the l^vel
abotl Bhldl profits: will be held to be unreasonable or exorbitant.
The possible alternatives have been analyzed in considerable detail. A
definition •hiah would been stated in terms of p^ return on
investment or net worth wafl rejected bteatUM o4' Hie administrative difficult is L which would be involved in computing the vrlue of an investment
in examining corporate financial structures,

La »»*"**£ &11OWUUSV

for differences in risk, A definition *#!: eh would bare employed aggregate
dollar profits in a base period as the test fras rejected becs.use it
would have made no allowance for the varying changes in vclrime of output which have occurred in different industries since the base period,
A definition stated in terms of profits as a percentage of dollar sales
was rejected because it would have amounted to a standard of costs plus

a percentage of cotts and would thus have guaranteed rising prices to
cover increased overhead per unit ae volume declined and would also
have ironhlded for enormous increases in aggregate profits in many cases
where Government purchases caused an expansion of output.
The Office proposes to adopt for internal use in defining unreasonable and exorbitant profits a standard which will be computed as

First, an industry's output in the current year will be compared

with its output in the year 1941 (the accounting period closest
to th-3 year October 1, 194-0 - October i, 1941 v/hich ie specified in the
Emergency Price Control Act) and the percentage of increase in output will
be determined.

Second, the industry's aggregate profits in 1941 will

be ascertained and this figure will be increased by a percentage which
is one-half as large as the percentage of increase in output. Third,
to the sum time obt ined there will be added a return of 7% on additions
to investment since 1941• Fourth, profits in excess of the resulting
total will be held to be unreasonable and exorbitant.
This definition i l a compromise betrcen the extremely rigorous
standard which woula have been involved in defining unreasonable and
exorbitant profits in terms of a fixed percentage on investment or a
simple base period aggregate, on the one haadg ant- oho extremely generous
standard that would have been involved in defining Buoh profits in te::ae
of a percentage on sales, on the other hand. It., effect will be to permit inaustries to realize increasing aggregate profit:: and an increasing
return or: investment as volume expands, but it will not permit them to
realise a constant margin on sales or an in profit which is


proportionate to the increase in output.

In short, it will eliminate any

increase in profits which is attributable to an increase in price since
1941 and a part of the increase which is attributable to the increase in
output occasioned by the growth of Government expenditures.

It will combine

increasing aggregate profits and an increasing return on investment with
a declining margin on sales.
In some cases it may appear that profits in the base period of
1941 were themselves unreasonable or exorbitant.

The Office is consider-

ing the feasibility in such cases of defining unreasonableness and exorbitance in terms of the extent to which the increase between 1939 and 1941
of an industry's profits as a percentage of sales exceeded the increase
realized by industry in general.

In order to bring the industry in ques-

tion into line with industry as a whole, its 1941 profits would be deflated in making the computations described above.
The Office is now making a statistical analysis, industry by
industry, of the movement of profits between 1941 and 1943 in order to determine the significance of these standards. This work will be completed
within the next two weeks.
Whenever profits are found to be unreasonable or exorbitant,
the maximum price of the commodity in question will be reduced to a point
which is calculated, in the light of realized and probable future changes
in output and in costs, to prevent producers in general from realizing
net profits before income and profits taxes which are in excess of the
limits set forth above.

It is recognized, of course, that there will

be cases in which the standard of unreasonableness and exorbitance must


be modified in detail to fit the peculiar circumstances of a particular
industry* and cases in which considerations other than those relating
to profits must he taken into account.
The foregoing discussion relates to those cases in which
prices will be reduced because profits are unreasonable or exorbitant.
There may be other cases, however, in which prices will be reduced even
though profits are not held to be unreasonable or exorbitant, if such
action is calculated to contribute to the prevention of inflation. This
may occur:
1. Where prices were caught by the General Maximum Price Regulation or initially set by a specific regulation at a level higher
than that required for fairness and equity to producers and consumers.

Where a cut is required directly to relieve an undue squeeze

at a later stage of the production or distribution of a particular
commodity in order to maintain the price of that commodity at retail.

Where it is possible indirectly to relieve pressure on

producers or distributors by reducing the prices of collateral cost
items which are not themselves the subjects of a squeeze, thus assisting them to preserve the level of prices at retail.

Where a price cut at an earlier stage of production will

be carried through by competition or can be carried through by OFA
to the retail level, thus reducing the cost of living.

Where goods are sold to agencies of the Federal Government,

so that a price out will directly reduce public expenditures.


Where a price cut at an earlier stage of production will be

carried through by competition, or by the coat-plus ?>rovisions of contracts at later sti$£»a or where i t can be carried through by 0P& or
where it can 1M carried throu^x by 0PA or by th« renegotiation of eon*
tract* *o s* indirectly to r96.^Q9 public expenditures.

Where costs per unit of output have declined, as & ctonsequenoe

of expansion of output or a reduction In %hm oentn of material*, whilt
prtomn hnro rom.inm& statbl* or har« failed to Mediae in orotxsrtion
to the redixotion iu oo«t«.

-here i&d«pende&t action tit different d&tes hae distorted

the normal differential between the prices of related ooanodities and
reduction of the higher prices will serve to restore the normal relat i o n s ip.
la such oases, guuilama prices ttay be net below the level which i s required
solely to prevent unreasonable or exorbitant profits,

They mist, however,

be set at levels which are generally fair and equitable within the aeaning
of the iltaer&eney Price Control 4ot of 1942,
to suMiaarises

It i s proposed to establish three areas with res*

peet to the relationship of profits to s»uclnun prices.

Within the lower

area* a&JcUran prices any be increased because profit* are held to be so
low that prices are not generally fair and equitabla.

Within the vpp*r

area, saxisust prices oust be reduced because profit* are unreasonable and

In the middle area, prioe» itre generally fair J*JUI equitable

and profit*? are not held to be unreasonable or exorbitant,

this area, how*

everv is vide enough to pemit the 'Office to reduce taaxirauja prices for reasons other than the fact that profits are held to be unreasonable or exorbitant • as long as profit« are hiph enough so that prio«s nay be held to
be generally fair and equitable.