The following article will guide you about how does profit differ from other factor incomes.
(a) Often confusion arises due to the fact that profit is treated as the return to both capital and entrepreneurship. The two terms interest and profit are often used as though they are interchangeable. Both are payments made to the suppliers of capital. But, it is necessary to distinguish between interest and profit. If the funds for investment are provided by the creditors of the company in the form of loans, the return to capital is treated as interest.
In contrast, when money capital is supplied by shareholder who are the owners of the company, the returns to capital are described as profit. In truth, the opportunity cost concept described alone should be applied to profits of shareholders. It is to be noted that the shareholders have foregone the interest they could earn by purchasing risk-free bonds.
So, it is necessary to make a deduction equal to this implicit interest from their dividend income in order to arrive at the true or net profit. In practice, it is very difficult to calculate pure profit. This is why the profit figures reported by the accountant will include implicit wages, interest and rent.
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(b) Profit differs from rent, wages and interest in the following three ways:
1. Profit may be Negative:
The capitalist incentive system is known as the profit and loss system. Efficient firms make profits; inefficient firms lose money and go out of business. But rent, wages and interest can never be negative.
2. Profit Shows Greater Fluctuation than any other Factor Income:
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But wages and interest are normally fixed for a specific time period (e.g., a wage of Rs. 300 per week or an interest of 12% per annum). But it is not possible to fix the rate of profit in advance, because revenue and costs are uncertain.
3. Profit is a Residue:
Some economists feel that profit is a functional return or return paid to the entrepreneur for performing certain special functions in an organisation. But, this is not the whole truth. There is general agreement among economists that profit is a residual item.
This means that profit is what is left with the entrepreneur after meeting all the expenses or paying the others of other factors. The other factor incomes remain contractually fixed per period and have to be paid in advance, i.e., before sales are made and revenues realised.