Discuss the nature of profit and critically examine Professor Knight’s theory of profit


Profit may be defined as the reward earned by the entrepreneur for his two fold services to production, namely management and risk-taking. The entrepreneur plans the business, hires the services of land, labour and capital and organizes then to his best ability. He pays rent, wages and capital at fixed rate. What remains after paying those is called Profit. The amount of profit is thus uncertain.

According to Professor Knight, profit is the reward for uncertainty-bearing and not for risk, taking in a business. According to him there are two kinds of risks which entrepreneur has to bear? Some risks are of such a nature that they can be anticipated to a fair degree of accuracy e.g. the risk of death, accident etc and so can be insured in return for premium. The entrepreneur can include the payment made in the form of premium in the total cost of production. So such risk which can be calculated and inscribed should not entitle entrepreneur to a profit. 

On the other hand, there are some risks which are unpredictable and unforeseen and so they are non-insurable. For instance, if the demand for product of entrepreneur suddenly comes down due to change sin fashions, tastes etc, then he may no be able to cover his total costs of production. Such risks which are unforeseen and cannot be statistically measured are called by Knight as uncertainty-bearing risks. Profits according to him are the reward of uncertainty-bearing rather than risk taking which is insurable.

Criticism:
Professor Knight’s Theory of profit can be criticized on the following grounds.

1. The total profits which an entrepreneur receives cannot be attributed solely to the element of uncertainty in a business. He performs other functions also such as coordinating, bargaining and innovation in the business. So he must be paid for these services also.

2. It is not simply due to uncertainty bearing that the supply of entrepreneur is restricted. There are other factors also which influence the supply of the entrepreneur. For instance lack of knowledge, lack of capital, lack of opportunity etc do restrict the supply of an entrepreneur in a business.

3. Uncertainty bearing can not be elevated to the status of a factor of production. It is an element of real costs which means exertion, abstinence, sacrifice etc as distinguished from money cost. Cost is not generally measured in terms of real cost. We know that capital is a factor of production but no abstinence that is needed to have capital.

4. Knight’s theory does not seem to have much relevance to the real world. Business combines to estimate profits ex-ante in defiance of this theory. This theory has been criticised as heavily insulated from empirical testing and empirical relevance.

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