Theory of Profit

Theory of Profit
for BBS Business Economics
By
Khemraj Subedi
Associate Professor
M.Phil in Economics
PhD Scholar in Economics
Tikapur Multiple Campus
Far Western University

Meaning of Profit
 Profit simply means a positive gain generated
from business operations or investment after
subtracting all expenses or costs.
 In a layman language, profit refers to an
income that flow to investor.
 In economic terms profit is defined as a reward
received by an entrepreneur by combining all
the factors of production to serve the need of
individuals in the economy faced with
uncertainties.
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Profit
Meaning and Types of Profit
 Generally, the excess of income over his
expenditure is called as profit.
 In economic sense, profit is the net income of a
business after all the other costs such as rent, wages,
and interest etc have been deducted from the total
income.
 Prof. Hansen, “profits are residual income left after
all the payments have been made.”
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Gross Profit and Net Profit:
 Gross profit is difference total revenue and total cost
of the production. When we call profit it is normally
gross profit.
 Gross profit consists of the following elements:
1. Monopoly gains
2. Windfall gains or Chance profits
3. Depreciation and maintenance charges
4. Imputed cost etc.
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 Net profit or Pure profit is the income received by
the producer after deducting explicit as well as
implicit costs.
 Net profit is the reward for the following functions:
1. Reward for risk and uncertainty.
2. Reward for coordination
3. Reward for innovation
4. Reward for managerial ability.
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Uncertainty Bearing Theory of
Profit
 This theory was propounded by an American
economist Prof. Frank H. Knight.
 This theory, starts on the foundation of
Hawley’s risk bearing theory. Knight agrees
with Hawley that profit is a reward for risk-
taking.
 There are two types of risks viz. foreseeable
risk and unforeseeable risk. According to
Knight unforeseeable risk is called uncertainty
beaming 6

Uncertainty Bearing Theory of Profit
 Knight, regards profit as the reward for bearing
non-insurable risks and uncertainties.
 He distinguishes between insurable and non-
insurable risks.
 Certain risks are measurable, the probability of
their occurrence can be statistically calculated.
 The risks of fire, theft, flood and death by
accident are insurable. These risks are borne by
the insurance company.
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Uncertainty Bearing Theory of Profit
 The premium paid for insurance is included in
the cost of production.
 According to Knight these foreseen risks are
not genuine economic risks eligible for any
remuneration of profit.
 In other words, insurable risk does not give
rise to profit.
 According to Knight profit is due to non-
insurable risk or unforeseeable risk.
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According to Knight profit is due to non-insurable
risk or unforeseeable risk and such risk are as
follows:
(a) Competitive risk:
(b) Technical risk:
(c) Risk of government intervention:
(d) Business Cyclical risk:
(e) Risk of change in demand a product:
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Conclusions
# Prof. Knight calls these risks as ‘uncertainties’
and ‘it is uncertainties in this sense which explains
profit in the proper use of the term’.
#These risks cannot be foreseen and measured,
they become non- insurable and the uncertainties
have to be borne by the entrepreneur.
#According to this theory there is a direct
relationship between profit and uncertainty
bearing.
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Criticism
 Profit is reward for innovation not uncertainty.
 Not direct relation between profit and
uncertainty.
 Profit is reward for avoidance of uncertainty.
 Uncertainty is not factor of production.
 Proft is reward for all things performed by
organization.
 This theory throws no light on monopoly profit.
 Profit rward of good bargaining power.
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Theory of Profit

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