Functions of Profit

Profit serves a very important function in a free enterprise economy. High profits are the sign that customers want more of he output of the industry. High profits provide the incentive for firms to expand output and for more firms to enter the industry in the long run. For a firm of above-average efficiency, profits represent the reward for greater efficiency. On the other hand, lower profits or losses are the sign that customers want less of the commodity and that production are not efficient. Thus, profits provide the incentive for firms to increase their efficiency or produce less of the commodity, for some firms to leave the industry for more profitable one. Profits, therefore, provide important sign for the reallocation of society’s resources to reflect changes in customer’s tastes, preferences, and demand over time. Similarly, it provides incentive, innovation and increase productivity and takes risks.
If profit system is not perfect, government in free-enterprise economic system often take step to modify the operation of the profit system to make it more nearly consistent with broad social goals. For example, governments pass minimum wage. Legislation and pollution emission standard to internalize to polluting firms and the social cost of the pollution they create.
To understand the theory of firm behavior and the role of the firm in a free enterprise economic economy, one must understand the nature and functions of profits. Indeed, profits are such key element that the system would fail to operate without profits and profit motive. Profits and the profit motive play an important and growing role in the efficient allocation of economic resources worldwide.
Even in planned economies, where estate ownership rather than private enterprise has been typical, the profit motive is increasingly being used as a spur to efficient resource use. In the former East Bloc countries, the Soviet Union, China and other nations, new profit incentives for manages and workers have led to increasing by product quality and cost efficiency. Thus profits and the profit motive play an important role in the optimal allocation of economic resources worldwide.
In summary following points can be outlined as a role and functions of profits.
? Profit serves as a signal to change the rate of output or for the firms to enter or leave the industry.
? It provides incentive to introduce innovations.
? It is the signal of firm to know to what extent consumer attached with that firm.
? It is the signal for resource allocation (more or less).
? It is the reward for innovation and productivity. Similarly, profit is motivating factor for mew products, new production methods and providing good customer service.
? Sometime above normal profits caused by barriers to entry or monopoly power granted by state.
Use of Price Elasticity in Business Decisions
The concept of price elasticity of demand has important practical applications in business or managerial decision-making. Generally, a businessman has to consider whether a lowering of price will lead to an increase in the demand for his product, and if so, to what extent and whether his profits would increase as result therefore. In fact, many businesses have failed due to lack of attention to the elasticity of demand. If the increase in sales is more than proportionate to the decline in price, his total revenue will increase and his profits might be greater. Alternatively, if the increase in sales is less than proportionate, total revenue will decline and his profits will definitely be less. In general, for commodities whose demand is elastic it will pay businessman to charge relatively low prices, while on those whose demand is inelastic, he would be better off with a higher price. Sound understanding of the elasticity of demand is important, for much of the success of the enterprise. Some important business applications of price elasticity are as follows: