WHAT IS PROFIT???

• Profit in economics, return on capital, also called

earnings, minus the costs of maintaining land,
labor, and capital
• In economic theory, profit is the reward for RISK
taken by ENTERPRISE
• Profit is a firm’s total revenue minus total cost.
• In economics, economic profit is the difference
between a company's total revenue and its
opportunity costs
 PROFIT
• It is a return to the entrepreneur for the use of
his entrepreneurial ability
• Entrepreneurial ability may be of two types
such as i) risk taking
& ii) uncertainty-bearing
• Economic profit is differ from accounting profit
(after deducting implicit cost (e.g. wages of
mgmt, interest on capital of owner) from gross
profit we get pure profit)
 HOW PROFIT DIFFERS FROM
OTHER INCOME???
1. It is residual income which can not be
fixed in advance.
2. It fluctuate more than other incomes and
can be negative.
3. Profits are uncertain.
 KINDS OF PROFIT
1. Earnings of Management

2. Monopoly Profits

3. Windfall Profits

4. Profits as Functional Rewards

 ROLE OF PROFIT
1. An index of performance of the firm

2. A premium to cover costs of staying in

business

3. Ensures supply of re-investible capital.

Why are Profits Necessary???

 To sustain/survival
 To run business( cover cost & run)
 To grow/expansion
 To develop R&D
 To earn reliability of Investors/Lenders
 Profit Maximisation
• Conventional theory of firm assumes profit
maximisation as the sole objective of
business firm.
• A profit-maximizing firm chooses both its
inputs and its outputs with the sole goal of
achieving maximum economic profits

– To maximize the difference between total

revenue and total economic costs
 Profit Maximization

• If firms are strictly profit maximizers,

they will make decisions in a “marginal”
way
– Examine the marginal profit obtainable
from producing one more unit of hiring one
additional laborer
 Assumptions of the model
1. A firm is a producing unit and as such it
converts various inputs into outputs of higher
value under a given technique of production.
2. The basic objective of each firm is to earn
maximum profit.
3. A firm operates under a given market condition.
4. A firm will select that alternative course of action
which helps to maximize consistent profits
5. A firm makes an attempt to change its prices,
input and output quantity to maximize its profit.
 Profit Maximizing Conditions
π = TR – TC
Where π = Profit
TR = Total Revenue
TC = Total Cost
There are 2 conditions that must be full filled to for
TR – TC to be maximized.
1. Necessary Condition
2. Secondary or Supplementary or Sufficient
Condition
Necessary/First Order Condition
MR = MC
Where
MR = Marginal Revenue: It is the revenue obtained
from the production and sale of one additional
unit of output.
MC = Marginal Cost : It is the cost arising due to
the production of one additional unit of output.
 π = TR - TC

dπ /dX = dTR/dX – dTC/dX =0

dTR/dX = dTC/dX
Where, dTR/dX is the slope of TR or MR
And dTC/dX is the slope of TC or MC

Hence, MR = MC

First condition is proved.

 TC
Y
TR
S1 TR
Revenue & Cost (Rs)

S2

O X
Q1 Q2 Q3

Quantity of Goods/Output
 Second Order/Sufficient Condition
This condition must be satisfied under
decreasing MR & increasing MC or MC
curve must cuts MR curve from below.
This makes the sufficient condition.
Or
The second order derivative of the profit
function is negative.
 d2π /dX2 = d2(TR)/dX2 – d2(TC)/dx2 < 0

d2(TR)/dX2 < d2(TC)/dx2

Since, d2(TR)/dX2 gives slope of MR Curve

d2(TC)/dx2 gives slope of MC Curve

Slope of MR < Slope of MC

Second condition proved

 Y
Revenue & Cost (Rs)

P1
MC

P2
Profit
MR

Q1 Q2
O X

Quantity of Goods/Output
 Profit Maximisation
Quantity TR TC Profit MR MC Change in
(Q) (TR-TC) (ΔTR/ΔQ) (ΔTC/ΔQ) Profit (MR-MC)

0 0 3 -3 - - -

1 6 6 0 6 3 3

2 12 8 4 6 2 4

3 18 12 6 6 4 2

4 24 17 7 6 5 1

5 30 23 7 6 6 0

6 36 30 6 6 7 -1

7 42 40 2 6 10 -4

8 48 51 -3 6 11 -5
Revenue & Cost (Rs)

Profit ATC
MC

MR

Quantity of Goods/Output
 Critique of Profit Maximisation
Theory
• As per the traditional economics, it is rational
behaviour of the owner, that he can maximise
his income by putting given amount of effort.
• The survival of the firm depends upon the
entrepreneur's ability to maximise profit in long
run.
• Firm may pursue goals other than profit
maximisation,but they can achieve these
subsidiary goals much easier if they aim for
profit maximisation.
 Criticism of the theory
• The assumptions of profit maximisation is unrealistic in
the real world.
• The assumption of firms are owner-managed is not valid
in the modern world.
• Business decisions may not be optimal due to absence
of information.
• Modern business firm divides itself into different depts,
so functions of each dept may not fit the other.
• In the modern oligopolistic market condition the small
firms can not pursue the objective profit maximisation.
• Lack of predictive power of and risk averse qualities of
manager results in less than max profit.
• Profit is intensely personal,
• Necessary and moral.
• Understand it.
• Pursue it.
• Make it.
• Enjoy it.
• Apologize to no one.