THE ROLE OF PROFIT IN AN ECONOMY
The most common definition of profit is the difference between the costs of production and the revenue that is earned thorough sales. However, economists have a different definition of economic profit. The formula that they use is the difference between total revenues and the total opportunity cost of all inputs used (Crystal&Lipsey,2004).Moreover, economists distinguish profit in two ways; normal and super-normal. The former is the amount of profit that is sufficient to keep the firm in the business and the latter is the profit which excesses the normal, so firms can increase the price of the product they sell. (Wall, 2009).There is also the sub-normal profit which is the profit that is below normal and the business must do some changes in order to survive in the industry.
Assuming that the firm is successful and has profit, it can “invest” it in many ways. First of all, firms can use their profit in research and development area. This leads to the maximization of their current profit and getting more advance technology to make their product faster and with lower cost. “This profit is particularly important for some industries such as oil exploration and car manufacture. Without this investment the economy will stagnate and lose international competitiveness, leading to job losses in some sectors”. ( http://www.economicshelp.org/blog/business/the-role-of-profit-in-an-economy, Date of access:06/03/10).Manny firms are public limited companies and they issued shares in order to raised capital, but giving away control. However, by issuing shares, the firm made a commitment to the shareholders; if the make profit they will share it with them in the form of dividends. Super-normal profit leads to higher dividends and encourage people to enter or buy more shares of that firm. Moreover, shareholders are an important source of finance for companies. Finally, firms have employees, so they have to pay them a certain amount of money. Maximization of their profit gives the firm the opportunity to reward its employees by raising their wages, besides it is the hard work of the individuals that made the firm successful and they deserve a raise in their salary. By doing so, the firm can attract more employees and in the same time keep their current workers.
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Moreover, a function of profit can be a signal in the area of economy that are doing well; which means that that specific industry is making profit. As a result, more and more people are likely to get involve in the market, so that they can make more money. In other words, the existence of profit suggests that when the demand is high, firm can increase the price of their product resulting to a higher income and also makes entrepreneurs think that is worth to enter the market. It is believed that profit is the main reason for entrepreneurs going into business, but this is not always true. Enterprise can get motivated from the passion or excitement that their product or service is going to offer. Nevertheless, profit can encourage people to enter the world of market; it can also encourage risk taking and innovation. Ultimately profit is the reward for the risk taker that took his ideas and develops them in the market.
It is believed that most firms use their profit to pay their workers and shareholders, but this is not always true. Firms can use their existed profit to reinvest in the business; economist called it retained profit. Retained profit is the profit that firms keep in order to prevent a future disaster or even reinvest into the firm itself so that they can maximize their income. But firms may have some unexpected downturns during their operations; in order to save and secure their survival, retained profit is used to provide insurance in the face of an economic crisis, recession or even at unexpected rise in the exchange rates.
Accorting to Harvey governments have benefits from profit and they use taxes in order to get their benefits. The effect of taxes on profit is important quotes Harvey. A tax on profits as they defined in tax law does affect prices and output and hence alters the allocation of resources. It also implies a higher effective tax rate in capital-intensive industries. (Harvey, 1998)
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Profit tends to be an emotive word, and firms which make large profits are often frowned upon it. But usually there is little justification for this since it is through profits and losses that the market economy works. Normal profit indicates people to accept the risk, in other words risk bearers are rewarded with profit, and thus teach people that risk is important in the world of market. Moreover, super profit has a variety of functions in the economy. Firstly, it indicates whether an industry should expand or should contrast. When the demand of a product is high, profits are usually high and firms have the power to expand, but when demand of the product is falling then the production should contrast. Secondly, it encourages firms to increase production and provides the resources for expansion. Super profits not only indicate that consumers want more of the firms' product; they are also the motivated power to produce those goods. However, when they make loss they tend to go out of production and the industry contrast. Thus, losses are as important as profits in the good operation of the economy. Finally, it can ensure that production is carried on by the most efficient business. In a competitive industry, the firm making the largest profit is the one whose cost is lowest. It is more likely to expand production and if necessary can afford to pay more factors to do so. On the other hand, small firms must follow the same plant, but to retained their factors. As a result any increase output of the more efficient firm will eventually lower the prise of product, leaving less efficient firms to make loss.
* Chrystal&Cipsey, 2004.ECONOMICS, Tenth edition, Oxford: Oxford university press
* Harvey. A, 1998, MODER ECONOMICS, Seventh edition, PALGRAVE
* Wall.N, Marcousé.I, Lines.D&Martin.B,1996, the complete A-Z ECONOMICS&BUSSINESS STUDIES handbook, Hodder&Stoughton
* http://www.economicshelp.org/blog/business/the-role-of-profit-in-an-economy, Date of access:06/03/10)