BATCH 21 - GROUP 1

 Milind R. Chandane - KHR2010SMBA21P009

 Sunita Kadam - KHR2010SMBA21P014

 Samrat Mazumder - KHR2010SMBA21P028

 Kaushal Patel - KHR2010SMBA21P042

 Divya Suresh - KHR2009SMBA18P042

 Vaibhav Gupta - KHR2010SMBA21P049

THEORIES OF PROFIT
 INTRODUCTION
 Profit is the reward of the entrepreneur, rather of
the entrepreneurial functions.
 Profits differ from the returns on other factors of
production such as land - rent, labour – wages,
capital – interests.
 Ordinary language - profit is all about excess of
income over costs of production. It includes –
earnings of self used factors – entrepreneur’s own
land, capital and his own labour work called
respectively.
 But in economics, profit is regarded as a reward for
the entrepreneurial functions of final decision
making and ultimate uncertainty – bearing.
 As a difference between total revenue and total cost
– as a reward for risk taking or uncertainty- bearing
as a reward for innovation and so on.
 TYPES OF PROFIT
1. Gross Profit and Net Profit:
 Gross Profit is the surplus profit which accrues to
a firm when it subtracts its total expenditure from
its total revenue.
 Gross Profit = Total Revenue – Total Cost.
 Which includes – net profit, remuneration for the
factors of production such as rent, interest, wages
etc and depreciation and maintenance charges.
 Net Profit or Pure Profit is the residual left with
the entrepreneur after deducting the remuneration
for the factors of production contributed by
entrepreneur, depreciation and maintenance
charges and extra personal profits from gross
profits.
 Net Profit is a reward for co-ordination, reward for
innovation, reward for risk taking and reward for
uncertainty bearing.
2. Business Profit and Economic Profit:
 Business Profit/Accounting Profit – excess of
revenue receipts over the cost of production of
goods and services.
 Business Profit = Total Revenue – Explicit Cost.
 Economic Profit includes both explicit and
implicit cost of production.
 Economic Profit = Total Revenue – Explicit and
Implicit Cost
3. Normal Profit and Super Normal Profit:
 Normal Profit is the profit which accrues to an
entrepreneur in the long period, where price of the
product = average cost (MC = MR and AR = AC).
 It is included in the cost of production.
 Super Normal Profit is a kind of surplus which
accrues to the super marginal entrepreneurs,
where price of product is higher than average cost
(Price > AC).
 It is not included in cost of production.
 THEORIES OF PROFIT
 Risk Theory of Profit

 Uncertainty - Bearing Theory of Profit

 Schumpeter’s Innovation Theory of Profit

 Marginal Productivity Theory

 Keynesian Theory of Profit

 RISK THEORY OF PROFIT
 Risk Theory of Profit was advocated by an American
Economist – Prof. Hawley.

 Profit arise because the entrepreneur undertakes

the risk of the business.

 If the entrepreneur is not rewarded he will not be

prepared to undertake risks.

 Higher the risk greater is the possibility of profit.

 TWO TYPES OF RISK
1. Insurable Risks:
 These are predictable/measurable and which are
insurable for – fire, theft, flood, accident etc
(which are the risks in business).
2. Non Insurable Risks:
 These are unforeseeable risks or cannot be
measured/identified. For instance, competitive
risks, technical risks, risk of government risk
arising out of business cycle.
 UNCERTAINTY-BEARING
THEORY OF PROFIT
 Uncertainty-Bearing Theory was advocated and
developed by Knights. It is also called as Modern
Theory of Profits.
 According to Knight, pure profits are linked with
uncertainty and risk bearing.
 There is a direct relationship between profit and
uncertainty bearing. Greater the uncertainty
bearing, higher the level of profits.
 It is considered as a separate factor of production.
 SCHUMPETER’S THEORY OF
INNOVATION
 The theory propounded by Schumpeter explains the
changes caused by innovation in the productive
process.
 According to this theory, profit is the reward of
innovations.
 Innovations refers to all those changes in the
production process with an objective of reducing
the cost of production.
 Innovation always reduces cost of production.
CHOOSING A HISTORICAL ROOT:
INNOVATION THEORY
CHOOSING A CURRENT ENG SYS
METHOD: STRATEGY DEVELOPMENT
OVERVIEW
CONNECTIONS BETWEEN
INNOVATION THEORY AND
STRATEGY DEVELOPMENT
WHICH MODERN DISCIPLINES
ARE IMPACTED BY SCHUMPETER’S
WORK?
 FORMS OF INNOVATION
 Introduction of a new technique or a new plant.

 Changes in the internal structure or organization’s

setup.

 Changes in the quality of the raw material.

 New sources of energy.

 Better method of salesmanship.

TECHNOLOGICAL INNOVATION
 Innovations revolutionize production in ways even
innovators can’t foresee…
 1954 expert vision of 2004 “home computer”
 MARGINAL PRODUCTIVITY
THEORY
 It was developed by Prof. Chapman – Profits are
equal to marginal worth of the entrepreneur and
are determined by marginal productivity of the
entrepreneur.
 When the marginal productivity is high, profits will
also be high and vice-versa.
 But it is difficult to measure the marginal
productivity of the entrepreneur.
 In case of other factors such as land, labour and
capital, marginal productivity can be measurable
either increasing or decreasing the units of factors.
 THREE(OR FOUR) MARGINALS
 The focus of marginal productivity theory is on
marginal product. There are, however, three
related "Marginals" that need to be noted:
 Marginal Product: This is the change in total
product resulting from an incremental change in
the quantity of the variable factor input used.
 Marginal Physical Product: This is another term
for marginal product which serves to emphasize
that production is measured in physical units rather
than monetary units.
 Marginal Revenue: This is the change in total
revenue resulting from an incremental change in
the quantity of the output produced.
 Marginal Revenue Product: This is the change in
total revenue resulting from an incremental change
in the quantity of the variable factor input used.
 Marginal Revenue Product = Marginal Product x

Marginal Revenue
 KEYNESIAN THEORY OF
PROFIT
 Relates money supply variability and uncertainty to
inflation and deflation.
 Variability of prices is a major cause of business
cycles.
 Wages and other costs of production adjust more
slowly than prices.
 Therefore price variability affects profits and
therefore investment.
 Investment cycles cause business cycles.
 THE GENERAL THEORY
 If the consumer is an economic optimizer, he/she
must be unable to buy the goods they planned to
buy because of some kind of constraint—risk,
convention, social institutions, cash, or ...?
 According to the classical model, the consumer
has insatiable wants.
 The consumer sells his/her labor in exchange for
enough income to buy the goods.
 The money value of the incomes received must
be equal to the value of the output produced.
 So how can unsold goods pile up in warehouses,
causing firms to lay off workers?
 The GENERAL THEORY (2)
 Say’s Law cannot hold. (“Supply creates its own
demand.”)

 If spending constraints are in effect, then there

will be a difference between (unlimited)
demand and “effective demand”.

 Actual (effective) demand will usually be

“deficient” to purchase total output.
 THE GENERAL THEORY (3)
 Microeconomics and macroeconomics do not
operate on the same basis. One cannot assume
that what is true for the economic agent at the
level of the individual consumer or firm is true in
aggregate. This amounts to the fallacy of
composition.
 In microeconomics, relative price effects
dominate. This is not true in macroeconomics. In
macroeconomics, income effects dominate,
making income more important in determining
aggregate economic behavior.
 THE GENERAL THEORY (4)
 Therefore, consumption depends primarily upon
income, not interest rates.
 C  C(r), but rather C = C(Y).

“People don’t change their standard of living

simply because the interest rate changes a few
points.”
 THE GENERAL THEORY (5)
 Saving occurs as the result of a habit, convention,
or social norm. People on average set aside a
certain percentage of their income. Saving is not
a function of interest rates.
S  S(r), but rather S = S(Y).

 Investment is related to interest rates, but also to

business people’s expectations for the future.
That is, I = I(r,E).
 THE GENERAL THEORY (6)
 If S = S(Y) and I = I(r,E), then there is no coordinating
variable to bring supply and demand together in the
loanable funds (capital) market.
 There is no reason to assume that supply equals demand
in this market.
 There is no reason to believe that there will be adequate
funds available to provide adequate investment demand.
 Since AD = C + I + G + NX, if investment demand is
deficient, then AD < AS, and inventories may pile up,
with unemployment a natural outcome.
 Without the coordinating variable, this will be the normal
outcome, with AD = AS only happening accidentally.
 THE GENERAL THEORY (7)
 Investment is a large and long-term commitment,
and is based on weakly supported expectations
about the future. This makes investment very
different from consumption. Investment decisions
will be erratic and emotional, and the risks
associated with investment are very high. As a
result, business decision makers will tend to
under-invest, further worsening the problem of
deficient investment.
 THE GENERAL THEORY (8)
 It may be a natural outcome of the organization
and institutions of modern economies that prices
and wages may not be fully flexible. This would
result in markets (like the labor and goods
markets) being unable to clear, leading to
unemployment and aggregate supply exceeding
demand.
 THE GENERAL THEORY (9)
 Money plays a key role in the economy. The use of
money leads to uncertainty, and makes “piercing
the veil” impossible. A money economy is
fundamentally different from a barter economy. The
classical dichotomy cannot hold.
 Interest rates are established in the money
market.
 People may rationally hoard money, holding
money for purposes other then making
transactions.
 Equilibrium is not AD=AS. It is a state that persists.
 CONSUMPTION

7000
6000
Consumption

5000
4000
3000
2000
1000
0
0 2000 4000 6000 8000 10000
Real GDP
 CONSUMPTION FUNCTION
 c = mpc = C/Yd = marginal
propensity to consume

C = C0 + mpc x Yd
C Or
C = C0 + cYd
Yd
C0

Yd
 ORIGINAL AGGREGATE
EXPENDITURE MODEL
Real GDP exceeds 45o line
planned expenditure Total Expenditure
10.0
C+I+G

8.0
Aggregate f
planned d e
expenditure 6.0
(trillions of
1992 4.0 b c Equilibrium
expenditure
dollars/year)
a Planned
C0 expenditure
exceeds
G
real GDP
I
0 2 4 6 8 10
Real GDP (trillions of 1992 dollars per year)
 ALGEBRA OF THE MODEL
But this means that
Y=C+I+G
1
But C = C0 + c(Y-T), Y  G
1 c
So Y = C0 + c(Y-T) + I + G
1
Y = C0 + cY – cT + I + G Y  I
1 c
Y – cY = C0 + I + G – cT
Y(1-c) = C0 + I + G – Ct 1
Y  C
1 c
1
Y*   C 0  I  G  cT  Y 
c
T
1 c But
1 c
 POLICIES OF PROFIT
 The main motive of the businessman is to make
profits. Every firm tries to maximize profits.
 The amount of profit that a firm makes shows its
success and efficiency.
 The profit that a firm makes should not be at the
point of exploitation of the people.
 It should be done through maximizing sales and
achieving the lowest cost of production.
 Businessman should provide goods and services of
good quality at reasonable prices.
THANK YOU