Generally, profit is the difference between revenue and cost of production. Revenue is amount obtained from sale. Mathematically,
Profit= total revenue-total cost
Or, Ω= R-C
If R> C then, Ω >0 i.e. profit
If R<C then, Ω < 0 i.e. loss
If R=C then, Ω = 0 i.e. break even point
Cost of production means the total amount paid to inputs used in the production. It includes wage paid to labor, interest paid to capital, rent paid to land, cost of raw materials, fuels, energies and so on. Both revenue and cost depends upon quantity produced and sold.
There are two types of cost. They are
- Explicit cost:
The cost of inputs hired or purchased is called explicit cost. It includes wages of labor hired, interest of money borrowed and invested, rent of land and building hired, cost of raw materials, fuels, energies purchased etc. These amounts are not income of the investors. These are cost to them. If we subtract explicit cost from revenue we obtain gross profit.
- Implicit cost
It is the cost of inputs owned by investors themselves which are used in the production. It includes the wage or salary of investors themselves, rent of land and building of investor themselves, interest of money of investors. If we subtract both explicit cost and implicit cost from the revenue we obtain net profit.
Types of profit:
There are 2 types of profit. They are;
- Gross profit
Excess revenue over the explicit cost of production is called gross profit. It is the difference between total revenue obtained from sale and explicit cost. Mathematically,
Gross profit = Total revenue – Explicit cost
- Net profit
Excess revenue over all types of cost of production is called net profit. It is the difference between total revenue obtained from sale and the sum of explicit cost and implicit cost. Mathematically,
Net profit= Total revenue – (explicit cost +implicit cost)
Gross profit includes cost of inputs owned by entrepreneur too but net profit doesn’t include it, that’s why, net profit is always less than gross profit. If not a single input used is owned by entrepreneur, the gross profit and net profit are equal. In this case, implicit cost is equal to 0.
Causes of profit
- Effective combination of other inputs
The organization brings other inputs like land, capital etc. together and combines for production, for it, organization should obtain profit as its remuneration.
Organization brings innovation in type and quality of products, management and technology. For it too the organization should earn profit.
- Bargaining power
Every organization has bargaining power due to more or less control in the market, resources, and special skills and so on. For it too organization should earn profit.
- Risk involved in business
There is always risk involved in business due to different reasons. For taking risk too, the organization should earn profit as compensation.
Some economists consider that organization should earn profit for bearing uncertainty due to unforeseeable or non insurable risk.