PROFIT

An economic profit or loss is the

difference between the revenue received
from the sale of an output and the cost of
the inputs used.

Introduction
Profit is the reward gained by risk taking
entrepreneurs when the revenue earned from
selling a given amount of output exceeds the total
costs of producing that output.
Profit measures the return to risk when
committing scarce resources to a market or
industry.
Entrepreneurs organise factors of production and
take risks for which they require an adequate
rate of return.

Total Profits
= Total Revenue (TR) Total

NORMAL PROFIT
In markets which are perfectly competitive, the
profit available to a single firm in the long run is
called normal profit.
This exists when total revenue, TR, equals total
cost, TC.
Normal profit is defined as the minimum reward
that is just sufficient to keep the entrepreneur
supplying their enterprise.
In other words, the reward is just covering
opportunity cost - that is, just better than the
next best alternative.

Super-Normal (Economic) Profit

If a firm makes more than normal profit it is
called super-normal profit.
Supernormal profit is also called economic
profit, and abnormal profit, and is earned when
total revenue is greater than the total costs.
Total costs include a reward to all the factors,
including normal profit.
The level of super-normal profits available to a
firm is largely determined by the level of
competition in a market.

Marginal Profits
Marginal profit is the additional profit
from selling one extra unit.
A profit per unit will be achieved
when marginal revenue (MR) is
greater than marginal cost (MC).
At profit maximisation, marginal
profit is zero because MC = MR.

Objectives of Profit
Investment in research and
development
Reward for shareholders
Aid for economies
Tool to stimulate government
finances

Theories of Profits
Profits of businesses depend on the
successful management of risks and
uncertainties by entrepreneurs.
These risks can be cost risks due to
change in wage rates, prices, or
technology, and other market risks.
Different economists have presented
different views on profit.

Theories of Profit
1. Hawley's Risk Bearing Theory of
Profit.
2. Uncertainty Theory of Profit.
3. Rent Theory of Profit.
4. Marginal Productivity Theory of
Profit.
5. Dynamic Theory of Profit.
6. Monopoly Theory of Profit.

Hawley's Risk Bearing Theory of

Profit.
This risk bearing theory of profit is
associated with the name of F.B. Hawley.
"Profit is the reward of risk taking in a
business. During the conduct of any
business activity, all other factors of
production, i.e., land, labour and capital
have their guaranteed incomes from the
entrepreneur. They are least concerned
whether the entrepreneur makes profit or
undergoes losses".

Hawley's Risk Bearing Theory of

Profit.
According to Hawley, profit is a payment or
a reward for the assumption of risks by the
entrepreneur.
The 'greater the risk, the higher must be
the profits.
It is because if the return on risky
enterprise is at the same level as that
obtained from the safe investment, then
not a single entrepreneur will invest his
capital in a risky enterprise.

Criticism
The modern economists believe that there is no doubt that
profits contain some remuneration for risk-taking in a
business but it is wrong to assume that profits are in their
entirely due to the element of risk- The profits can also
arise on account of better management, better supervision
or they may be due to the monopolistic position of the
entrepreneur or they may be due to sheer chance, etc.,
etc.
Another criticism levied by Carver is that profits arise not
because risks are borne but because the superior
entrepreneurs are able to reduce the risks.
It is also pointed out that profits are never in proportion to
the risk undertaken, it can happen that in a more risky
enterprise, the profits may be low and high in a less risky
enterprise.

Uncertainty Theory of
Profit

According to Professor Knight:

"Profit is the reward for uncertainty-bearing and not of
risk-taking in a business".
Two kinds of risks which entrepreneur has to bear like
Some risks are of such a nature that they can be anticipated to
a fair degree of accuracy, e.g., the risk of death, accident,
etc., and which can be insured .
On the other hand, there are some risks which are
unpredictable and unforeseen and so they are non-insurable.

Risks which are unforeseen and cannot be statistically

measured are called by Knight, as uncertainty-bearing
risks.
"Profits, according to him are the reward of uncertaintybearing rather than risk-taking which is insurable".

Criticism
(i) The total profits which an entrepreneur
receives cannot be attributed solely to the
element of uncertainty in a business. He
performs other functions also such as
coordinating, bargaining, and innovation in
the business. So he must be paid for these
services also.
(ii) It is not simply due to uncertainty-bearing
that the supply of entrepreneur is restricted.
There are other factors also which influence
the supply the entrepreneur.

Rent Theory of Profit

According to Francis A Walker "Profits are of the
same genius as rent".
(i) Profit is rental in character. Just as superior grades
of land earn more rent than the inferior grades of
land, similarly superior entrepreneurs due to their
exceptional ability or opportunity earn more profits
than the inferior entrepreneurs.
(ii) As in the case of land, there is a no-rent or
marginal land, so in the business also is a no-profit or
marginal entrepreneur. The marginal entrepreneur is
one whose ultimate receipts from the sale of the
commodities just cover his total costs.

Rent Theory of Profit

(iii) Just as rent is measured from the
non-rent land, in the same way profits of
the superior businessmen are calculated
from the marginal entrepreneur.
(iv) The rent does not enter into price of
agricultural production of the
manufactured goods.
It can be concluded that profits are the
reward of differential business ability.

Criticism
(i) It simply provides a measure of profit. It does not throw
light on the nature of profit which is of more importance.
(ii) Marshall is of the opinion that there is much difference
between the rent of land and the entrepreneur's profit.
(iii) It is also pointed out that profit may not form a part of
the cost of production of a commodity in the short period
but in the long period if the business is to be continued, it
must enter in the price of the product.
(iv) Profits do not arise simply because of the superior or
exceptional ability of the entrepreneur, but they can also
result due to chance gains or monopolistic position of the
entrepreneur or they may be of the nature of the windfall
income.

Marginal Productivity Theory of

Profit
"The earning of entrepreneur like the reward
of other factors of production can be
explained by the marginal productivity
analysis".
Under conditions of perfect competition, the
reward of the entrepreneur tends to be equal
to the .marginal social worth of the employer.
If the marginal productivity of the employer is
high, the profit will also be high and the
marginal net productivity is low, then profit
will also be low.

Criticism
The enterprise is very large, if for
finding out the marginal net
productivity of the entrepreneur, we
withdraw it from the business, then it
will disorganize the entire productive
organization.
Thus, it becomes very difficult to
ascertain the marginal net
productivity of the labour.

Dynamic Theory of Profit

According to J.B. Clark Profit arises only in
a dynamic economy. An economy is said to
be dynamic when there is a change in the
population growth or a change in the method
of production or a change in the consumers
wants, etc., A society which is without these
changes is called a static society. In a static
society only monopoly profits continue to
exist. All other economic profits are gradually
eliminated by competition

Dynamic Theory of Profit

In a dynamic society, an entrepreneur is always
confronted with continuous unpredictable changes
in demand for his product.
The variation in demand may take place due to
change in fashions, tastes, standard of living,
distribution of income, population, new inventions,
international repercussion and technological
advances, etc.
A prudent entrepreneur will always keep an eye on
the future demand for his products.
Profits are a reward, of progress, Schumpeter calls
it the reward of innovation.

Criticism
Prof, Knight has criticized the Clarkian Theory of
profit on the ground that it is wrong to attribute all
profits to dynamic changes.
According to him, there are certain changes which
are of a recurring and calculable nature.
The profits do not arise on those regular changes
but on those which are unforeseen or
unpredictable.
He thus observes that: "It is not dynamic changes
nor any changes as such which cause profits but
he divergence of actual conditions from those
which have been expected and on the basis of
which business arrangements have been made".

Monopoly Theory of
Profit
Monopolistic and monopolistic competition in
the market also give rise to profits.
The firms under monopoly or monopolistic
competition have greater control over the price
of the product.
They are the price makers rather than the price
takers.
As such they raise prices by restricting the level
of output and thus keep profit at higher level.
Monopoly power, thus, is the basic sources of
business profits.

Criticism
It is said that monopoly is no doubt
an important cause and source of
monopoly profits but it does not
replace other theories.
Monopoly power only supplements
other theories.

Schumpeters Innovation
Theory
Joseph Schumpeter propounded a theory called
innovation according to which profits are the
reward for innovation.
He advocated that innovation is the introduction
of a new product, new technology, new method
of production, and new sources of raw
materials.
This helps in lowering the cost of production or
improving the quality of production.
Innovation also includes new policy or measure
by an entrepreneur for an organization.

Innovation Can Take Place In

Two Ways
Reducing the cost of production and
earning high profit. The cost of
production can be reduced by
introducing new machines and
improving production techniques.
Stimulating the demand by
enhancing the existing improvement
or finding new markets.

Criticism
Ignores uncertainty as a source of
profit
Denies the role of risk in profit