Theories Of Profit

Dr. Hari Prapan Sharma

 Introduction
• Classical economists have regarded profit
maximization as the sole objective of the
business in any capitalist economy.

• In practice, firms rarely seek to maximise

profits.
 Reasons For Limiting Profit
• Maintaining Business Goodwill
• Wage Consideration
• Avoiding High Taxation & Government’s
Intervention
• Avoiding Risk
• Obstructing Potential Competition
• Goal Of Domination & Leadership in
Market
Reasons For Limiting Profit (contd.)

• Enlightened Self-Interest
• Idealism & Service Motivation
• Liquidity Preferences
 Profit
• Profit may mean the compensation
received by a firm for its managerial
function. It is called normal profit which is
a minimum sum essential to induce the
firm to remain in business.

Profit =Profit
Total Revenue
= Total – Total
Revenue – Total Cost Cost
 Features of Profit
• It is not a predetermined contractual
payment.
• It is not a fixed remuneration.
• It is a residual surplus.
• It is uncertain.
 Gross Profit
• Gross profit is surplus of total money
expenditure incurred by a firm after the
production process.

Gross Profit = Net Profit + Implicit rent + Implicit Wages+ Implicit Interest +
normal profit + depreciation & maintenance charges
+ non-enterprenerial profit
 Net Profit
• Net Profit is pure economic profit earned
by entrepreneur for his services &
efficiency.
Net Profit = Gross Profit – (Implicit rent + Implicit Wages+ Implicit Interest +
normal profit + depreciation & maintenance charges
+ non-entrepreneurial profit)

Net Profit = Economic Profit or Pure Business Profit

Hawley’s Risk Theory Of Profit
“The riskier the industry the higher its profit
rate”
Since entrepreneur take the risks of
business, he is entitled to receive profit as
his rewards.
Profit is commensurate with risk.
 Criticisms:
• There are no functional relationship
between risk and profit.
• Profit is not based on entrepreneur's ability
to undertake risks, but rather as his
capability of risk avoidance.
• The theory disregards many other factors
attributable to profit and just concentrate
on risks.
Knight’s Theory Of Risk Uncertainty
And Profit
Knight defines pure profit as “the difference
between the returns actually realized by
entrepreneur and competitive rate of
Interest in high class gilt-edged securities”

• Acc. To him, Risks are of two type:

 Insurable risk
 Non insurable risk
 Examples of Non-insurable Risks

• Demand Fluctuation
• Trade Cycle
• Technological changes
• Outbreak of war
• Changes in Govt. policies
• Competition
 Criticisms:
• Uncertainty-bearing is not sole
determinant of profit.
• It is business ability rather than
atmosphere of uncertainty which a leads
to high reward of profits.
• Theory does not suit to monopoly
business phenomenon.
• The uncertainty element can’t be
quantified to impute profit.
 Dynamic Theory of Profit
• Clark defines profit as the difference between
selling price and the cost resulting in the
changes in demand and supply conditions.
Profit is the surplus over cost.
• Changes that causes profit to emerge:
 Increase in population
 Changes in tastes and preferences
 Multiplication of wants
 Capital formation
 Technological advancement
 Criticism:
• It gives an artificial dichotomy of ‘profit’
and ‘wages of management’
• All dynamic changes lead to profit, but
only unpredictable changes gives rise to
the profit.
• Clarks theory not stress the element of the
risk involved in the business due to
dynamic changes.
 Rent Theory of Profit:
Francis A Walker.
• "Profits are of the same genius as rent".
• The main points of Walker's Theory of Profit
can be summed up as such:
• (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.
• (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.
 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.
Thank You