BAIIISemEconomics Prepared ByDr Suneyna Department of Economics Meaning
BAI(II-Sem)Economics Prepared By-Dr. Suneyna Department of Economics
Meaning The term profit has distinct meaning for different people, such as businessmen, accountants, policymakers, workers and economists. Profit simply means a positive gain generated from business operations or investment after subtracting all expenses or costs.
Meaning in Economic terms Profit is defined as a reward received by an entrepreneur by combining all the factors of production to serve the need of individuals in the economy faced with uncertainties. In a layman language, profit refers to an income that flow to investor. In accountancy, profit implies excess of revenue over all paid-out costs. Profit in economics is termed as a pure profit or economic profit or just profit.
Types of Profit: i. Accounting Profit: Refers to the total earnings of an organization. It is a return that is calculated as a difference between revenue and costs, including both manufacturing and overhead expenses. The costs are generally explicit costs, which refer to cash payments made by the organization to outsiders for its goods and services. The accounting profit is calculated as: Accounting Profit= TR-(W + R + I + M) = TRExplicit Costs TR = Total Revenue W = Wages and Salaries R = Rent I = Interest M = Cost of Materials
ii. Economic Profit: Takes into account both explicit costs and implicit costs or imputed costs. Implicit that is foregone which an entrepreneur can gain from the next best alternative use of resources. Thus, implicit costs are also known as opportunity cost. The examples of implicit costs are rents on own land, salary of proprietor, and interest on entrepreneur’s own investment. The economic profit is calculated as: Economic profit = Total revenue-(Explicit costs + implicit costs) Economic profit is not always positive; it can also be negative, which is called economic loss. Economic profit indicates that resources of a business are efficiently utilized, whereas economic loss indicates that business resources can be better employed elsewhere.
THEORIES OF PROFITDynamic Theory: This theory is associated with the name of J. B. Clark, who is of the opinion that there can be no profit in the static world but because we are not living in a stationary state. Ours is a dynamic world and some changes are constantly taking place. The clever entrepreneur foresees these changes. He is a pioneer. Somehow by invention or otherwise, he lower his cost of production and makes profits.
Risk Theory: The theory of profit is associated with F. B. Hawley’s name. He says, profit is the reward for risks and responsibilities that the undertaker…. subjects himself to. Most people do worry about the risk which makes them hesitate to take a plunge in business. According to Hawley the greater the risk, the higher must be the expected gain in order to induce them to start the business.
Uncertainty-bearing Theory: According to Prof. Knight, it is uncertainty-bearing rather than risk-taking which is the special function of the entrepreneur and leads to profit. We have seen that there are certain risks which are foreseen and provided against. Risks of death and of accident like fire and ship sinking are statistically determinable. But the economic risks, e. g. , risks of the marketability of the product due to shifts in demand, are unforeseen and unpredictable. Knight will not call them risks but uncertainty. And acc. To him the entrepreneur gets remuneration for bearing uncertainties (unforeseeable risks)
Innovations Theory: American economist Joseph Schumpeter has singled out for special treatment the par; played by innovations. It is the dynamic changes which give rise to profits according to the dynamic theory of profits. The daring and the dynamic entrepreneurs continue to hit at one innovation or another, keeping their business ahead of others and thus making handsome profits. According to Schumpeter, the principal function of the entrepreneur is to make innovations and profits are a reward for successful innovations.
Will Profits Fall to Zero Profits tend to decline due to competition but they will never become zero, as otherwise all enterprise would end.
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