Explain briefly Modern Theory of Profit

Briefly Explanation of the Modern Theory of Profit

Several theories have been put forward to explain the determination of profits. There is the risk theory of profit and also uncertainty-bearing theory. Some economists regard profit as the rent of ability. There are others who advocate the dynamic theory of profit. The question arises which theory shall we accept? How do profits arise? Here we are thinking of not gross profit but net profit. The fact is that in the real world, there are several causes that give rise to profit, but the principal cause is uncertainty. It is certain this is the basic cause of profit. 

This uncertainty is due to the dynamic nature of the world. In this real world of ours, some or other change is always taking place. But only such changes are the cause of profit, as can not be foreseen as we have read in Knight’s theory. No entrepreneur can foresee all these changes nor are the circumstances under his control. The world is dynamic due to two sets of factors (a) internal and (b) external. In other words, there are certain changes that the entrepreneur himself brings about such as innovations and there are other changes that are brought about by external forces. 

The external changes are of two kinds (a) regular changes like trade fluctuations which affect all profits and (b) irregular as breaking of fire, earthquakes, floods, strikes, changes in tasks, changes due to government policies, war, etc. Thus profit arises out of changes. In a static world there is no change, hence no profit. In an economy where nothing changes there can be no profit. But only such changes are the causes of profits which cannot be foreseen as we have read in Knight’s theory.

However, in the static world profits can arise in one way i.e. owing to monopoly – The monopoly profits arise in a dynamic world also. Besides monopoly profit can arise also from any other position of advantage.

In short, we can say there are two sources of profit (a) uncertainty and (b) position of special advantage, monopoly, or otherwise.

Thus there is no one theory that will explain profit but a synthesis of all the theories mentioned above. Profits are a reward for the services of the entrepreneur. The supply of entrepreneurial ability is limited. Whereas the demand for their services is very great.

The rate of profit at any given moment will depend on the interaction of demand and supply of entrepreneurial ability, risking capital and in the long run, it must be such as to call forth and maintain the supply of entrepreneurial services.