Let us study about Profit. After reading this article you will learn about: 1. Definition of Profit 2. Distinguishing Features of Profit.
Definition of Profit:
It is the profit that motivates an entrepreneur to undertake business. In a market economy this profit motive serves as an incentive in allocating resources in the production of a commodity in accordance with the needs and tastes of the buyers. If he fails to move in the direction signalled by the buyers his chance of getting higher profit gets reduced.
However, though profit motive is the basic motive (ignoring social responsibility of private businessmen) or a private firm or industry, this is not true for all producers/entrepreneurs.
Modern governments produce many goods and provide services to the people not with profit motive. It is the welfare motive (i.e., welfare of the people) that encourages government to offer public goods and services (like health, education, etc.).
Profit is the reward that goes to the entrepreneur. Since he is in charge of the enterprise, he must get profit as his income. It is to be emphasized here that the notion of profit as understood by economists is different from those of accountants.
To an accountant, profit is defined as the difference between total revenue after the sale of a product and total expenses incurred for producing a product. However, economists’ definition of total costs is different from the accountants’ definition. Accountants only consider explicit costs and ignore opportunity cost.
Economists always define costs in terms of alternatives forgone or opportunity cost or implicit cost. While measuring the volume of profit, accountants do not incorporate implicit or opportunity costs in total costs. But economists include such opportunity cost. Thus, profit—as defined by economists —is the total revenue minus total costs, where total costs include opportunity costs.
Further, economists often speak about normal profit and supernormal profit. When total revenues and total costs are the same, normal profit arises, though business has a different notion of normal profit. Businessmen call such situation no-profit no-loss situation.
But, in economics, normal profit is included in the cost of production, or normal profit refers to the amount of accounting profits when economic profit or pure profit is equal to zero. A firm, however, makes supernormal profit when total revenue exceeds total cost.
Distinguishing Features of Profit:
Profit differs from other factor earnings (i.e., rent, wage and interest) in the following ways:
(a) Rent, wage and interest are all contractual incomes since these are paid in accordance with the agreement or contracts made between the parties. Profit, on the other hand, is a residual income. The boss or the entrepreneur must be the residual claimant.
After the payment is made for contractual income, if there is any surplus, the entrepreneur will receive that. There is no guarantee that an ordinary shareholder will receive dividend income arising out of profit of a business firm. As such, there is no contractual obligation on the part of a company to pay dividend to an ordinary shareholder.
(b) Being contractual income, rent, wage and interest can never be zero or negative. But profit may be zero or negative.
(c) Profit fluctuates rather more widely than the income of other factors of production. Rent, interest and wages fluctuate rather steadily. But profit may change violently whenever economic conditions change.
(d) Rent, interest and wage form a part of cost of production. A firm has to meet this cost if it wants to stay in business. If it fails to meet this cost or cannot pay dividend to the shareholders, it will have to go out of business in the long run. Since (net) profit is a surplus income it does not form cost of production.