Question

What are the Functions of Profit in Economy? Describe in detail. 

 

Answer 1

Profit can be defined as 'a residual amount available to the entrepreneur after other factors of production have been duly paid.'

 

FUNCTIONS OF PROFIT -

 

From ancient period to modern times, several questions have been raised about the justification of profit. Sometimes it was considered just and necessary and sometimes unnecessary and wrong. In socialism and communism, it was not merely considered unnecessary but was also called unjustified and even condemnable. According to communism, profits arise only out of the exploitation of workers and in a just communist system, there was no place for profits. However, later, even communist countries realized that without profit, no firm (even government companies) can survive for long or their growth can take place. As against this, in capitalistic countries profits have always been considered as essential not only for a firm but also for the economy as a whole.

The biggest justification for profit comes from the various functions performed by it and obviously, in the absence of profit all these activities will come to a stand-still.

1. The first function of profit is that it not only creates a motivation in the entrepreneur to bear risk and uncertainty but also creates a capability in him to bear losses. If a firm is receiving continuous profits it can bear losses also sometimes. A firm which gets losses only, will have to be closed down.

2. Profit is a measure of efficiency and productivity. Increase in profit is an indicator of increasing efficiency. Similarly profit is a basis of distinguishing between an efficient and an inefficient firm. A profit making firm will normally be an efficient one while a loss making firm will be designated as an inefficient firm.

3. Profits not only motivate an entrepreneur for innovation but also provide resources for this purpose. In the absence of profits, programmes of technological improvement, innovation would be adversely affected because without resources research and development (R&D) is not possible.

4. Profits provide necessary funds for investment for any expansion programme of a company. In most of the good companies, only a fraction of total profit is distributed amongst share-holders as a divided, the major portion of profit is used for investment.

5. If the profits in an industry are high, then other firms and companies working in other industries, are attracted towards this particular industry. As a result, production is increased and prices are reduced. In other words, the increased requirements of customers are fulfilled by the entry of new firms. In this way, the flow of resources in the desired direction is ensured in an economy. Thus, profit creates a self adjustment process in an economy, which ensures optimum allocation of resources, amongst different sectors of the economy.

6. Profits are a big source of revenue to the government. As we know, government imposes a good amount of income tax on the profits of firms and companies. As the profits of firms and companies increase, the tax revenue of government also automatically increases. This revenue is used by government for public purposes. Apart from this, many companies also use a part of their profits for charity and other social welfare programmes, which benefit people. Thus, profits of companies are beneficial to society.

In this way we see that profits perform many functions which are useful for the economy. The famous management expert Peter Drucker has also considered profits as essential from a social point of view. According to him, the losses or failures of some firms are compensated by the profits of other companies. If profits do not arise, then all economic activities will come to a standstill.

Here, it is very essential to distinguish between 'profit' and 'profiteering'. Profiteering creates an adverse impact in the economy because it is based on the exploitation of consumers and workers. Profit, on the other hand, is a normal and essential process. Hence, it should be considered necessary for the society.

 

 

Profit can be defined as 'a residual amount available to the entrepreneur after other factors of production have been duly paid.'