Profit: Meaning, Elements and Characteristics

Let us make an in-depth study of Profit:-

1. Meaning and Definition of Profit 2. Elements of Profits 3. Characteristics of Profit 4. Nature of Profit 5. Justification of Profit

Meaning and Definition of Profit:

“The share of the national income that goes to the entrepreneur is known as Profit”.

The term “Profit” is usually understood to mean the difference between the total sale-proceeds obtained by a businessman and his total expenses of production. It is the surplus that remains in the hands of the businessman after paying rent, wages, interest on borrowed capital etc.

In other words, we can say that Profit is the surplus of income over expenses of production according to a businessman. It is the amount left with him after he has made payments for all factor services used by him in the process of production. But he may not have been careful in calculating all such expenses of production in the economic sense. Therefore, economists regard businessman’s Profit as “Gross Profit”.

Definitions:

Important definitions of Profit as given by different authors are as follows:

1. According to Prof. Marshall – “Profit is the earning of management”.

2. According to Walker – “Profit is the rent of ability”.

3. According to Croome – “Profit is the reward for uninsured risks”.

4. According to Ely – “Profit is a surplus over and above the expenses of production”.

5. As Taussig has said – “Profit is a mixed and vexed income.”

6. According to Prof. J. K. Mehta – “The element of uncertainty introduces a fourth category of sacrifice in the productive activities of man in a dynamic world. This category is risk-taking or uncertainty bearing. It is remunerated by Profit.”

Since economists are of this opinion that

Profit = Gross Profit – (Rent + Wages + Interest)

Elements of Profits:

Essential elements of Profits are as follows:

1. Profits Include Some Reward for Risk-Taking and Uncertainty-Bearing:

One of the important functions of an entrepreneur is to assume the risks of production. And for this risk-taking he gets some income.

2. Profits Include some Income which Businessmen Manage to Secure:

This is an important question as to how a businessman should secure Profits? In order to secure profits the businessmen either tries on account of their monopolistic control over supply or because of the existence of imperfect competition. In real life, every businessman is often able to secure some monopolistic or semi-monopolistic control over the markets. Therefore, he is normally in a position to charge a slightly higher price than would be possible under perfect competition. He therefore, earns some extra income.

3. The Existence of Market Imperfections may Swell Profits in another Way:

Competition in the market for labour or for any other factor of production may be, and is often, imperfect, as a result of which an employer is in a position to exploit the situation and pay those factors an amount of remuneration which may be less than the values of their respective marginal net products. The difference will be his profits.

4. Profits often Contain Large Amounts of Fortuitous Gains:

These gains arise from mere good luck in certain enterprises. A sudden shift in demand may drive up prices, and so may bring large gains to the entrepreneurs.

Characteristics of Profit:

Profit as we have seen is the reward for enterprise which goes to the entrepreneur- owner (individual or collective) of the firm. The reward for an entrepreneur cannot be determined in advance. The reward for entrepreneur depends on his calculations regarding future business expectations. If these calculations prove correct, he may earn profit but if they prove wrong he has to bear losses also.

The important characteristics or peculiarities of Profit are as follows:

1. Profit is a Residual Reward:

It means profit is received by the entrepreneur as a residual surplus, which is left over after meeting all the business expenses from the sales receipts.

2. It is not Contractual or Pre-Determined Payment:

Remember Profit is not like rent, wages, interest and Profit a pre-determined contractual payment. Therefore, it can be said that it is not an explicit cost.

3. It is the End Result of Business:

In profit other factors rewards such as rent, wages and interest are received by their agents during the process of production. Profit is realised by the entrepreneur only after the completion of the business, i.e., after completing the sales and meeting all the expenses.

4. Profit is a Dynamic Concept:

Profit depends on many factors such as entrepreneur’s organisational ability, changes in market demand and supply conditions, element of monopoly power, innovation such as production of new items, discovery of new-markets, new modes of advertising and sales propaganda etc. and many other dynamics changes in the economy.

5. It is not Determined through Formal Factors of Market:

In all other factor prices are determined in a formal market.

For example:

Rent is determined in the land market, wages in the labour market and interest in the capital market. There is no such formal entrepreneurial market for determination of profit.

6. Profit is not Fixed Income, it is Uncertain and Fluctuating:

Profit being a residual income cannot be fixed in a pre-determined manner. It varies from time to time. It will be high during a period of prosperity. It declines during recession. There may be even losses during a depression. Here, other factor incomes are generally stable over a period of time, Profit is widely fluctuating.

Nature of Profit:

The nature of Profit has even been the most perplexed and troubled problem in the opinion of the economists. In early days, the classical economists regarded Profit as accruing to the capitalist who supplied capital and owned the business, Profits are determined after making all necessary payments from the total income of the business. It is the demand and supply of entrepreneur. Regarding Nature of Profit Prof. Taussig has said that it is a “mixed and vexed income.’ Walker looked upon “Profit as the reward of the entrepreneur with a superior ability than others”.

According to Clark, Knight and Schumpeter – “It is an income which arises out of change, uncertainty and friction inherent in a dynamic world, and which the belated operation of competitive forces tends to eliminate.”

In this connection the Marxian economists Veblen and Hobson are of this opinion that “Profit is an unearned income and attribute it to the existence of institutional monopolies established by a few capitalists. Monopoly profits arise because a monopolist is able to restrict output and keep the price of his product much above the average cost of production.”

Justification of Profit:

Our next discussion regarding Profit is “whether the payment of Profit to entrepreneur is justified or not”. There are different views taken by different economists over this point. According to Karl Marx—”The Profit is earned by labour therefore it should go to labour. Whatever amount other people’s taking they are taking away from the shares of labour. Therefore, he is of this opinion that “Profit is a legalized robbery”.

There is no doubt that there are many elements in actual profits, which cannot be defended. The employer may swell his Profits by paying to the labourers less than their marginal worth, or by ‘sweating’ the helpless workmen. Privileges yielding valuable financial benefits may be obtained dishonestly.

The industrialists may bribe the legislators into passing tariff legislation. On the stock exchange gambling and unscrupulous manipulation of the market may enable persons to become rich. Monopoly points may be secured which are many ways unjustifiable.

There are innumerable other ways in which large sums can be collected by foul means. Nothing can be said in defence of these types of profits. The result often forms the low commercial mortality of the people. The proper remedy for such practices in full freedom of competition and the improvement in the moral spirit of the public. But the condemnation of these types of Profits does not also mean the condemnation of normal Profits earned by honest work. They are the inevitable outcome of the institution of private property. Just as you must pay people for waiting, so you must pay them for risk-taking and uncertainty-bearing.

An entrepreneur, by assuming risks and by directing the productive organisation, renders useful services to the society for which he must be paid. The services of businessmen are no less valuable than those of workers. By his superior organizing, by his boldness and sagacity in shouldering risks, an entrepreneur increases the productivity of the economic organisation in a greater ratio than would have been possible otherwise.

Further, it has been observed that Profits have been the spur to progress under the present organisation and to stop profits would mean the abolition of progress. Of course if we will abolish private property, the payment of profits will not be necessary. But the abolition of private property raises various questions, which we will have to analyse from very close. But the general view is that the payment of Profit for the work to entrepreneur is justified.