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Different between Gross Profit and Net Profit | Economics

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The upcoming discussion will update you about the difference between gross profit and net profit.

(a) Profit is commonly taken to mean the difference between total revenue and total cost. It is the reward for and monetary incentive to the successful conduct of business.

Profit is different from other factor incomes. Rent arises to land as a factor; wages arise to labour and interest to capital. But, it is very difficult to identify a particular factor to which profit accrues as a return. The reason is easy to find out. Unlike the other factors, the fourth factor performs a number of functions at the same time. This is why profit is treated as mixed income.

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So is why it is always difficult to isolate profits from other factor incomes such as wages, interest and rent. This is especially the case when the entrepreneur (i.e., the owner of capital) is also the manager. The owner of a small business may make a total (gross) profit of Rs. 50,000 in a year. This is called gross profit, because it is arrived at by deducting all factor payments from his total sales revenue.

However, a deeper analysis will reveal that his true profit will be much less than the above figure (Rs. 50,000), because it will contain implicit factor incomes such as implicit wages, implicit interest and implicit rent. The entrepreneur who contributes his own labour to the business must deduct from the gross profits an amount equal to his managerial wage.

This refers to the opportunity cost of his own labour, i.e., an amount equal to what he might earn as a salaried person. If he has invested his own savings in the business, then a part of his gross profit will represent interest on capital. Again, if he has set up his office building on his own land, a certain amount will also have to be deducted as rent. The amount of rent to be deducted will be roughly equal to the amount he would have received by letting the premises to a tenant.

In truth, the opportunity cost to the entre­preneur of using his own managerial labour, capital and land in his own business represents implicit wages, interest and rent. All these items have to be deducted from gross profit in order to arrive at net (pure) profit. Net profit is the net return to the entrepreneur for risk-taking and uncertainty- bearing. The student is now advised to give a numerical example of the type given in the text to prove his (her) point.

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(b) Normal profit is implicit (transfer) cost of the entrepreneur. This is minimum sum required by an entrepreneur to stay in business in the long run. In those markets, where entry is free (as in perfect competition or monopolistic competition) a firm is able to make only normal profit. Any entrepreneurial return above normal profit is excess (super-normal) profit. It is also called net (pure) profit. For such profit to excess in the long run there must exist certain barriers to the entry of new firms into an industry.

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