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HELLO!
I am Michelle M. Bongalonta
I am here to discuss a topic
in Managerial Economics….
PROFIT ANALYSIS
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Concepts of Profit Analysis

Components Assumptions Methods Limitations

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Key Components of Profit Analysis

Selling Level or Total Per unit

Sales Mix price per volume of fixed variable
unit activity costs cost
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Assumptions in Profit Analysis

Selling Per unit Total

Unchanged ✋ Sales Mix price per
unit
variable
cost
fixed
costs

Level or
volume of
activity 👉 Units Produced = Units Sold
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Method adopted for Profit Analysis

The main method adopted to

carry out profit analysis is the
profit volume ratio:

Shareholders ′ 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
𝑃𝑟𝑜𝑓𝑖𝑡 𝑉𝑜𝑙𝑢𝑚𝑒 𝑅𝑎𝑡𝑖𝑜 = 𝑥 100
Sales
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Limitations of Profit Analysis

▸ The profit analysis is a short run

and marginal analysis which presumes
the unit variable costs and the unit
revenues to be constant.
“
Profit is not the legitimate purpose of
business. The legitimate purpose of business
is to provide a product or service that people
need and do it so well that it’s profitable.
- James Rouse
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Gross Profit
versus
Net Profit
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Gross Profit
is surplus of total money
expenditure incurred by a
firm after the production
process.
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Net Profit
is gross profit minus fixed
costs. To determine net
profit, you begin with your
gross profit figure, then
subtract your fixed costs.
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Normal Profit vs Supernormal Profit

Normal Super-normal (economic) If a

The minimum reward that is just
sufficient to keep the
entrepreneur supplying their
enterprise.
This exists when total revenue
equals total cost.
TR = TC
firm makes more than normal
profit it is called super-normal
profit. Also called Abnormal
profit,
and is earned when total
revenue is greater than the total
costs.
TR > TC
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THEORIES OF PROFIT
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Theories of Profit

The Rent The Wage The Marginal Productivity

Profit is the rent Profits are best regarded as Profit is equal to the marginal productivity of the entrepreneur. The
of ability simply a form of wages. They amount which the community is liable to produce with the help of
accrue to the entrepreneur on entrepreneur over and above what it could produce with his help.
account of his special ability.

The Dynamic
The Uncertainty-bearing Profit is the difference between the
Profit is the reward of bearing non-insurable risks and price and the cost of the production
uncertainties. It is a deviation arising from uncertainty of the commodity.
The Risk
The entrepreneur exposes his
business to risk, and in turn
he receives a reward in the The Perfect Competition The Innovation
form of Profit because the
task of risk-taking is irksome. The entrepreneur as a business enterprise Profit as the reward to
itself and ‘Profits’ as his net income. enterprise and innovation
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The Rent Theory

American Economist Francis L. Walker

The essential nature of Profit does not differ from that of

rent because rent is a differential surplus accruing to the
superior land over the marginal or no rent land, similarly
profit is a differential surplus which accrues to the superior
ability entrepreneur over the marginal or no-profit
entrepreneur.
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The Rent Theory

The important criticisms of this theory are as follows:

a. This theory is unrealistic
b. It is not a true surplus
c. Profits only in a dynamic state
d. Profit is not gift of ability
e. Overlooks the important function of the entrepreneur as a
risk-bearer
f. Fails to explain the main causes of the size of Profits
g. Profits do not enter into price
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The Wage Theory

Prof. Taussig and Davenport

There is very close similarity between a labourer and

entrepreneur. Just as labourers receive wages for his
services, similarly entrepreneurs receive profit for his
service.
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The Wage Theory

This theory has been criticised for equating the functions of

an entrepreneur with that of the workers on the following
grounds:
a. Element of risk and uncertainty
b. Profit is flexible, it may vary
c. It is silent over the payment to shareholders
d. Entrepreneurs windfall or chance profits
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The Marginal Productivity Theory

German economist, T.H. Von Thunen and further by J.B.

Clark, Walras, Barone, Ricardo, and Marshall

Profit is the reward of an entrepreneur which is determined

by its marginal revenue productivity, the higher are the
profits and lower the marginal revenue productivity, the
lower are the profits of an entrepreneur
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The Marginal Productivity Theory

Important criticisms given by various economists are as

follows:
a. This theory is based on unrealistic assumptions
b. This theory fails to determine profit accurately
c. The concept of marginal revenue productivity of
entrepreneurship is a meaningless concept
d. It is one sided theory
e. This is a static theory
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The Dynamic Theory

Prof. J. B Clark
Profit is the reward of an entrepreneur which is determined
by its marginal revenue productivity, the higher are the
profits and lower the marginal revenue productivity, the
lower are the profits of an entrepreneur
(1) Changes or increase in population,
(2) Changes in tastes and preferences,
(3) Multiplication of wants,
(4) Capital formation,
(5) Technological advancement and
(6) Changes in the form of business organization.
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The Dynamic Theory

Clark’s dynamic theory of Profit has been severely criticised

by Prof. Knight and others on the following grounds:
a. All changes are not foreseen
b. This theory gives artificial dichotomy
c. All changes do not lead to Profit
d. The concept of frictional Profit is vague
e. Element of risk involved in business
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The Risk Theory of Profit

F. B. Hawley

It is definite that no entrepreneur will like to undertake risks

if he gets only the normal return. Therefore, the reward for
risk-taking must be higher than the actual value of the risk.
Further, it has been said that more risky the business, the
higher is the expected Profit rate.
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The Risk Theory of Profit

Like other theories, the risk theory of profit has also been
criticized on the following grounds:
a. There cannot be functional relationship between Risk
and Profit
b. Profit is not based on entrepreneur’s ability
c. It is an incomplete theory
d. Amount of Profit not related to size of risk involved
e. Concentrates mostly on risk and not on anything else
 Modern Theory or Perfect Competition or
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Demand and Supply Theory of Profit

It is definite that no entrepreneur will like to undertake risks

if he gets only the normal return. Therefore, the reward for
risk-taking must be higher than the actual value of the risk.
Further, it has been said that more risky the business, the
higher is the expected Profit rate.
 Modern Theory or Perfect Competition or
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Demand and Supply Theory of Profit

While criticizing this theory Knight has said that Profit has
been regarded as the reward for bearing non-insurable risks
and uncertainties, then under perfect competition there can
be no profit in the long-run. It is a static state where
population, capital, technology, tastes, business
organization and income do not change.
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Innovation Theory of Profit

Prof. Schumpeter

Profit as the reward to enterprise and innovation. In his

opinion, the entrepreneur initiates innovation in the
business and when he succeeds, he earns Profit as his
reward. Now, the question is what is innovation?
“Innovation means commercial application of new scientific
inventions and discoveries.”
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Innovation Theory of Profit

Schumpeter’s innovation theory has been criticised on the

following grounds:
a. Never considered Profit as the reward for risk-taking
b. No place of uncertainty
c. It is incomplete
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Break-even analysis
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The Break-even Components

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The Break-even Components

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The Break-even Components

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The Break-even Chart

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Assumptions of Break-Even Analysis

(i) The total costs may be classified into fixed and variable costs. It ignores semi-variable cost.
(ii) The cost and revenue functions remain linear.
(iii) The price of the product is assumed to be constant.
(iv) The volume of sales and volume of production are equal.
(v) The fixed costs remain constant over the volume under consideration.
(vi) It assumes constant rate of increase in variable cost.
(vii) It assumes constant technology and no improvement in labour efficiency.
(viii) The price of the product is assumed to be constant.
(ix) The factor price remains unaltered.
(x) Changes in input prices are ruled out.
(xi) In the case of multi-product firm, the product mix is stable.
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You have to be a winning player
just to break-even.
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THANKS!
Any questions?
😉