Theories Of Profit

Theories Of Profit Divya Jain

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. = Total Revenue – Total Cost Cost Profit =Profit Total Revenue – Total

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.

Thank You