THE ROLE OF PROFIT IN THE OPERATION OF A FREE ECONOMY

THE ROLE OF PROFIT IN THE OPERATION OF A FREE ECONOMY

             There are various theories which have been advanced from time to time regarding the nature of profit in a competitive economy. Almost all of them differ basically from one another and are inadequate to explain the actual role of profit in the operation free economy. The most important theories are:

        I.            Hawley’s Risk-bearing theory of profit.

      II.            Professor Knight’s uncertainty theory of profit.

    III.            Walker’s rent theory of profit.

    IV.            Clark’s dynamic theory of profit

HAWLEY’S RISK BEARING THEORY OF PROFIT

           This risk bearing theory of profit is associated with the name of F.B Hawley. According to him, profit is the reward of risk taking in business. During the conduct of any business activity, all other factors of production, i.e. land, labour, capital have their guaranteed income from the  entrepreneur. They are least concerned whether the entrepreneur makes profit or undergoes losses in a business activity. As we know, there are every chance at any moment in the variation of demand for the commodity produced, The demand may change due to changes in fashion, tastes, condition of trade, prices of substitutes, distribution of wealth, etc., or the project undertaken may prove to be a complete failure. In all such cases, if the entrepreneur is not able to cover his total costs from the sale of the commodities, then it is he who ultimately bears the loss. So he must be compensated for undertaking such risks.

              Thus, according to Hawley, profit is a payment or a reward for the assumption of risks by the entrepreneur. The greater the risk, the higher must be the profits. It is because if the return on risky enterprise is at the same level as that obtained from the safe investment, then not a single entrepreneur will invest his capital in a risky enterprise.

CRITICISM:

      Hawley’s risk theory of profit is criticized on the following grounds:

1.      According to Hawley’s, profit is a reward for bearing risks in a business the modern economists believe that there is no doubt that profit contain some remuneration for risk-taking in a business but it is wrong to assume that profits are in their entirely due to the element of risk. The profits can arise on account of better management, better supervision or they may be due to the monopolistic position of the entrepreneur or they may be due to sheer chance etc.

2.      Another criticism levied by carver is that profits arise not because risks are borne but because the superior entrepreneurs are able to reduce the risks.

3.      It is also pointed out that profit are never in proportion to the risk undertaken. It can happen that in a more risky enterprise, the profits may be low and high in a less risky enterprise.

4.      There are certain businesses where risks can be more or less accurately foreseen by statistical evidence, e.g. in insurance, the entrepreneurs who run these businesses earn profit. Thus theory fails to explain as to how the profits are earned in such business where the risk can be insured.