Question

Discuss the role of expected profit in a capitalist economy. Is the allocation of scarce resources determined by expected profit? Do companies have an incentive to produce as efficiently as possible? Discuss the Adam Smith proposition that consumers and businesses operating in their own self interest results in the best interest of society. Do you agree?

Answer 1

Expected profit is an incentive which attracts entrepreneurs, firms, companies etc to produce goods and services. It leads to growth and is reason for taking loans to expand capacity or production or to invest in new plants. Yes allocation of scare resources is determined by expected profits. Firms which expect greater profit will pay more for resources and resources will move from other sectors to these firms.

Yes firms have incentive to produce as efficiently as possible because that will lead to cost minimisation and profit maximisation.But some firms in govt sector have no such incentive as the employment of employees does not depend on performance and they have secured job. Adam Smith preposition is that led by invisible hand of self interest consumers and Business operating in their own self interest result in best interest of society. E. G firms will equate marginal cost with marginal revenue to maximise profits. Consumers will equate prices with marginal utility to maximise their welfare. In this process social welfare is maximised. Because as one can see in general equilibrium framework social welfare is maximised when p=mc and p=marginal utility. But there are some exceptions due to nature of public goods, externalities etc