The Nature Of Profit
We may define profit as the difference between the total expenses and the total revenue of a business. Some care is necessary to isolate profit from interest on capital and wages, particularly in the accounts of small businesses. Suppose, for example, that the accounts of a retail shopkeeper show that he has made 1000 euro profit in a year; the probability is that he has not charged in his profit and loss account anything as interest on capital or as a salary for himself. Suppose that the amount of capital employed is 2000 euro and that the current rate of interest 5 per cent.; 100 euro of the ‘profit’ is really the earnings of capital interest. Again, suppose that the manager of a similar kind of shop could expect to earn 600 euro per annum as a salaried employee; we must count 600 euro of the remaining 900 euro as wages rather than profit. We are now left with 300 euro as the true profit of the business, which cannot be attributed to the earnings of any other factor of production. This may be regarded as the additional payment to the proprietor, to induce him to enter business on his own account rather than to work for someone else and invest the capital in some safe security.
Having thus isolated profit we may note three ways in which it differs from the earnings of other factors of production. First, it may be negative, it may be a loss. This is true of no other kind of income. No employee would agree to work for negative wages, no landowner to let his land for a negative rent and no investor lend his money at a negative rate of interest. Entrepreneurs not uncommonly put in a year’s hard work and find themselves worse off at the end than they were at the beginning.
Secondly, profits fluctuate more than any other form of income. When prices and employment are rising profits rise more rapidly than any other form of income; conversely when prices and employment are falling profits fall more quickly than other incomes, which may indeed not fall at all.
Thirdly, profit is a different kind of income from the returns to other factors of production. Wages, rent and interest are contractual incomes, that is they are fixed in advance between the payer and the recipient. Profit is not the result of a contract; it is a residual income, being what is left of revenue after expenses have been met.
The Determination Of Profit
This being so, we should expect profits to be high when uncertainty is great and to be low when there is little uncertainty. Other things being equal, any entrepreneur would prefer to have his business in a line in which uncertainty is low. This brings about competition in these lines, which in turn brings down profit; entrepreneurs engage in lines in which there is a great deal of uncertainty only if there is a prospect of high profits by way of compensation. If a business could exist without any uncertainty at all profit would fall to zero since, there being no distinctive entrepreneurial function, the whole of the return could be attributed to the other factors of production.