Chapter Info (Click Here)
Book No. – 3 (Economics)
Book Name – Principles of Microeconomics (HL Ahuja)
What’s Inside the Chapter? (After Subscription)
1. Introduction
2. Profits as a Residual Income
3. Profits as a Dynamics Surplus: Clark’s Dynamic Theory of Profits
3.1. The Various Types of Changes
3.2. Knight’s Views on Dynamic Theory
4. Schumpeter’s Innovations Theory of Profits
5. Risk, Uncertainty and Profits: Knight’s Theory of Profits
5.1. Profits, Unpredictable Changes and Uncertainty
5.2. What Causes Uncertainty?
6. Role and Functions of Profits
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Theory of Profits
Chapter – 43
Introduction
After analysing rent, wages, and interest, economics examines profits, which are generally regarded as the reward for enterprise, the fourth factor of production; however, economists have long differed on the nature, origin, and role of profits, and no complete agreement has emerged regarding their true source.
The theory of profit has remained one of the most confused and controversial areas in economics, largely because economists disagree about the proper function of the entrepreneur.
One view considers the entrepreneur as the organiser and coordinator of the other factors of production; according to this approach:
Profits are earned for performing organisational and coordinating functions.
Enterprise is treated as a special type of labour.
Profits are regarded as a special form of wages.
Another view sees the entrepreneur as the bearer of risk and uncertainty because he controls the business and makes decisions regarding price and output; profits arise as compensation for bearing the possibility that these decisions may prove incorrect due to future business changes.
Joseph Schumpeter assigned the entrepreneur the role of an innovator and explained profits as the reward for introducing innovations into the economic system.
F.H. Knight emphasised uncertainty as the fundamental source of profits, arguing that the entrepreneur earns profits because he bears uncertainty inherent in economic activity.
Some economists treated profits as a form of non-functional income rather than as a reward for entrepreneurial functions:
J.M. Keynes associated profits with favourable movements in the general price level.
Joan Robinson, E.H. Chamberlin, and M. Kalecki linked profits to imperfect competition and monopoly.
According to the monopoly-based explanation:
The greater the degree of market imperfection or monopoly power, the greater the profits earned by entrepreneurs.
Profits are therefore connected with the ability to exercise market power rather than with entrepreneurial functions alone.
Different economists identified different primary sources of profits:
F.H. Knight → Uncertainty-bearing.
Schumpeter → Innovation.
Hawley → Risk-bearing.
Joan Robinson, E.H. Chamberlin, and M. Kalecki → Monopoly power and imperfect competition.
The passage argues that profits actually arise from multiple sources simultaneously, including uncertainty, innovation, risk-bearing, and monopoly power; consequently, no single theory of profit provides a complete explanation because each overlooks some important determinants of profits.
B.S. Keirstead advanced a more comprehensive view by arguing that profits originate from:
Monopoly or monopsony power.
Successful innovations.
Correct estimation of uncertain future conditions, whether specific to a particular industry or affecting the entire economy.
According to Keirstead, profits may exist as rewards for monopoly or monopsony advantages, for innovation, and for accurately anticipating uncertain future events, making profit a multifaceted phenomenon rather than the product of any one single factor.