Generally, the entrepreneur considers profit as excess revenue over the total cost. Therefore, profit is the net income of the firm. Business organizations associate different factors of production like land, capital, labor, raw materials, fuel, and energy, etc. to produce goods and services, and then the firm expects some rewards for organizing the production activities and distribution it to the market. Profit is thus the recompense for good management of resources.
In the market economy profit is the most significant incentive for the producers and business organizations to produce goods and services. Every business organization has a motive for profit maximization from its operation.
The business organization produces goods not for the charity rather for generating profits. In a dynamic and free-market economy, profit is only the major stimulating factor for new innovation and new products. The rate of profit in the economy gives a signal to producers to change their rate of output or to leave or to join the industry.
A higher rate of profit is the signal that buyers want more output from the particular producing units. These profits provide incentives for existing firms to increase their production volume and for new firms to enter into a market.
On the other side, low profits are the symbol that less output is being demanded by the consumers and that production methods or quality of goods are not sufficient enough to attract the consumer.
So, profit provides room for managers to think about reform in their production techniques and product quality if there are low rates of profit.
There are different theories concerning profit advocated by different economists. Among them, the innovation theory of profit developed by Joseph A. Schumpeter is one stating that the amount of profit is the outcome of innovation and profits are basically generated in the business organization if the managers are being capable to cope with innovation.
J.B. Clark developed the dynamic theory of profit and according to Clark; profit arises due to the dynamic changes in the societies. According to Clark, the major role of an entrepreneur and manager in a dynamic world is to yield benefits of the basic changes in the economy and thereby to endorse businesses.
According to F.B Hawley, profit is the reward of risk, and profit will be higher with a higher degree of risk and vice versa. Prof. Knight said that profit is the reward for uncertainty and undertaking of uninsured risk by the business firm.
Function and uses of profit
The major functions and uses of profit in managerial economics are pointed as below;
- It works as a reward to entrepreneurs for accepting the risk associated with their business decisions. Profit is the reward for taking uncertainty and risk by the business firms and managers. So, it encourages them to do new innovations and follow the dynamism of societies.
- Profit encourages business firms to lower the cost of production and use better production techniques and so that society and households can get better quality and better services.
- It is taken as the measure of managerial efficiency and successful way of business firms.
- The amount of profit works as the source of financing investment for a business undertaking and research and development activities in the market.
- Rising profit open the door for new entrepreneurs to enter into the market and for consumers, it’s better to get a competitive market rather than monopoly by several firms.
- Profit keeps the flow of factors into the product market from the factor market and keep the increase in demand from the household sectors and will work as the base to functioning an economy.
- Rising profits or supernormal profits are signals of good and fitted health of an economy and which will encourage further investment from domestic as well as foreign investors.
- The profit of the firms is an important source of revenue for the government.
- Profit ensures a supply of future capital in the economy and encourages innovation.
Therefore, profit is the reward for the working and risk-bearing capacity of an entrepreneur. It encourages new innovation and invention in the business organization. Higher profit is assumed as a result of effective and skillful management. Thus, there are several key functions of profit in managerial economics, and in managerial performance and business management profit is always taken as motivation to do more and invent more.