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Theories Of Profit And Rent

 Theories of Profit, Rent Theory of Profit

(A) The Dynamic Theory

         Prof. JB Clark propounded the dynamic theory of profit and according to him; profit is the difference between the price and the cost of production of the commodity. But the profit is the result of dynamic change. In a dynamic state, “five generic changes are going on, every one of which reacts on structure of society.” They are (1) population is increasing (2) Capital is increasing (3) Methods of production are improving (4) The forms of industrial establishment are changing the less efficient shops etc. are passing from the field and the most efficient are surviving (5) The wants of consumers are multiplying.

(B) The innovative Theory

            Prof. Schumpeter attributes profit to dynamic changes resulting from an innovation. To start with he takes a capitalist closed economy which is in a stationary equilibrium. This equilibrium is characterised by what Schumpeter calls a “circular flow” which continues to repeat itself for ever. In such a static state, there is perfectly competitive equilibrium. The price of each product just equals its cost of production and there is no profit.

Only exogenous factors like whether conditions can cause changes in the circular flow position. In the circular flow position goods are being produced at a constant rate. This routine work is being performed by the salaried managers. It is the entrepreneur who disturbs the channels of this circular floe by the introduction of an innovation. Thus Schumpeter assigns the role of an innovator not to the capitalist but to the entrepreneur.

(C) The Risk Theory

            The risk theory of profit is associated with FB Hawley who regards risk taking as the main function of the entrepreneur. Profit is the residual income which the entrepreneur receives for the reason that he assumes risks. The entrepreneur exposes his business to risk and receives in turn a reward in the form of profit since the task of risk taking is infuriating. Profit is an excess of payment above the actuarial value of risk. No entrepreneur will be willing to undertake risks if he gets only the normal return. Hence the reward for risk taking must be higher than the actual value of risk.

(D) The uncertainty Bearing Theory

            Prof. Frank H knight regards profit as the reward of bearing non insurable risks and uncertainties. He distinguishes amidst insurable and non-insurable risks. Certain risks are measurable in as much as the probability of their occurrence can be statistically calculated. The risk of fire theft of merchandise and of death by accident is insurable. Such risks are borne by the insurance company. There are certain unique risks which are incalculable. The probability of their occurrence cannot be statistically computed for the reason that of the presence of uncertainty in them.

            Such unforeseen risks relate to changes in prices, demand and supply etc. No insurance company can calculate the loss expected from such risks and hence they are non-insurable. Profit according to Knight is the reward of bearing non-insurable risks and uncertainties. It is a deviation arising from uncertainty between earning ex post and ex ante.

(E) Shackle’s Theory

            Prof. GLS Shackle has extended Knight’s theory of profit by introducing expectations under conditions of uncertainty. According to him, expectations are of two types: general and particular. General expectations relate to variables general to the economy as a whole. They are associated with such micro variables as the future reaction of a particular marketing strategy adopted by a firm, the future pricing policy of a competitive firm etc.

            The decisions of the business community are generally based on general expectations. If it regards them favourable investments are made. But there is subjective certainty in the case of general expectations. Their time horizon is about 12 months. As the general expectations have subjective certainty and their time horizon is also of reasonable duration, the business community is able to anticipate price and income increases correctly for the economy as a whole and by adopting appropriate inventory policies it earns windfall profit.

Rent Theory of Profit

            The rent theory was developed by an American economist Francis L Walker. Walker maintains that profit is the rent of ability. Like different grades of land, entrepreneurs are also of different abilities. Entrepreneurs of superior ability earn profit just as superior lands earn rent. According to Walker just as there is the marginal or no rent land, similarly there exists a marginal or no profit entrepreneur who earns only wages only wages of management. The marginal or no profit entrepreneur is the least efficient one earning profit not beyond an amount just sufficient to keep him in his present industry.

The industry managed by the marginal entrepreneur is similar to the marginal land. Just as land at the margin is no rent land, similarly the marginal entrepreneur earns no profit.

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