Profits: Dynamic Theory and Innovation Theory

Profit

Typically, a businessman believes that profit is the difference between income and expenses. However, this is referred to as gross profit in economics, not net profit. Therefore, we must make a number of concessions and deduct them from gross profit in order to arrive at net profit. Profits, however, are best understood in the context of economics as the net revenue of a company after all other expenses such as rent, salaries, and interest have been subtracted from the gross income.

Types of profit

Gross profit: The difference between an organization's total revenue (total sales) and its cost of products sold is its gross profit. Gross profit is the organization's net income after manufacturing and delivery expenses are subtracted from the price of the product. Gross profit is disclosed on every organization's income statement. Gross profit is calculated mathematically as revenue less cost of goods sold. Sales profit, gross margin, and gross income are additional terms for gross profit. Gross profit measures how effectively a company uses its resources. Only variable costs—such as direct labor, direct supplies, direct expenses, commission on sales, credit card fees, depreciation, utilities for the production process, etc.—are taken into account. However, it excludes fixed expenses that must be covered regardless of output level, which is zero. Employee salaries, rent, insurance, advertising, office supplies, interest rates, etc. are examples of fixed costs.

Net profit: A company's net profit is its revenue less all of its operational costs, debt obligations, dividends on preferred shares, and taxes. Net income or net earnings are other terms for net profit. Net Profit is the result of total revenue less total expenses. The final line, or bottom line, of the income statement is where you may find the net profit.

Theories of profit

• Dynamic theory of profit
• Innovation theory of profit

Dynamic theory of profit

This theory is developed by JB Clark, an American economist. This idea states that profit is the difference between the price of goods or services and their production costs. He distinguishes between a static economy and a dynamic economy. Profit does not exist in a static economy, or if it does, it is fictitious. However, in a dynamic economy, profit develops as a result of the dynamic social processes. In the actual world, changes happen all the time. He identifies five significant changes that are ongoing: I changes in population number; (ii) changes in the capital supply; (iii) changes in production methods; (iv) changes in the structure of commercial organizations; and (v) changes in the desires of people. He claims that as a result of these changes, profit develops in the dynamic society. Profits start to appear as a result of these changes in market supply and demand for commodities. These alterations are typical dynamic alterations. The business owner constantly seeks to make new, purposeful improvements. They enable him to lower his production costs and raise his earnings.

In a static society, neither supply nor demand fluctuates, or they do so at a predictable rate. In this scenario, wages, interest rates, and product prices all remain at their natural or normal levels. It implies that the entrepreneur won't make any money. If the cost of the good or service rises, competition will drive the price down to its equilibrium level, eliminating profits.

Profits are now the outcome of the aforementioned dynamic changes. These modifications widen the discrepancy between the product's price and its typical production cost, increasing the entrepreneur's earnings. Profits are the outcome of changes that occur in a changing society. Profit is produced by a certain alteration for a certain length of time. However, because one change is followed by another, changes happen continuously.

Criticisms

This theory has been criticized on the following grounds:

• Prof. Knight contends that none of these dynamic changes can be profitable. Profits only come from things that cannot be predicted.
• The hypothesis ignores the existence of a supply price for business skill, just like it does for every other factor of production.
• Profit and management earnings are artificially separated by the dynamic hypothesis.

Innovation theory of profit

The innovation hypothesis of profit was created by Joseph A. Schumpeter. According to his theory, an entrepreneur's primary duty is to introduce innovation into production, and the incentive for doing so is profit. Discovering and implementing a novel concept into the industrial process is the act of innovation. It is the use of a novel concept for profit, like introducing a new machine into a manufacturing process. both types of innovations

• Cost-cutting inventions that lower the cost of production. introduction of new equipment, adoption of a new or improved manufacturing process or system, utilization of a new raw material source, improved organizational structure, etc.
• Innovations that lower demand while raising product demand The launch of a new product, a new variety or quality of good, a new and improved ad approach, the discovery of a new market, etc. are some examples of innovations that increase demand.

If innovations are successful, they will lower per-unit costs, boost product demand, or allow producers to sell the product for more money than they did previously. Profit would result from successful developments in this way. In reality, making money is the reason innovations are introduced. Profit is therefore the driving force behind inventions. Additionally, if the innovation is profitable, there will be a benefit. Profit is therefore both the reason for and the result of innovation.

Criticisms

The following are some of the reasons why Schumpeter's innovation theory has drawn criticism:

• Risk and uncertainty are disregarded. This hypothesis has primarily been criticized for ignoring risks and uncertainty, which are significant sources of profit.
• Neglecting other aspects of becoming an entrepreneur He has focused only on the entrepreneur's role in invention. However, the entrepreneur is also expected to carry out additional duties including planning, coordinating, taking calculated risks, etc.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan