Profit has been defined as the difference between total revenue (value of output) and total cost (value of inputs). While the former is determined by the demand conditions in the market (i.e., physical volume of sales and product price), the latter is influenced by the supply conditions in the market.
Profit is the surplus left over after all other factors of production have been paid. It is different from the earnings of other factors of production in the sense that the former gets paid by the entrepreneur himself, while other factors get their reward from the entrepreneur. Other points of difference are as follows:
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(i) Profit is a residual income, so its size varies. Other factors get contractual income and are thus fixed.
(ii) Profit may be zero or even negative. Wages, interest and rent are however always positive.
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(iii) Under condition of imperfect competition, profit always tends to be more than the marginal cost of the firm. Under perfect competition, price is equal to the marginal cost. Thus, marginal cost is the limit below which the firm will not operate.
Profits are affected by the level of business activity. Business is brisk and profits are high, when business firms innovate and continuously upgrade the products as well as techniques of production.
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There would be low profits, if business activity is at a low ebb. We often find low profits in nascent industries. The volume of profits made by a firm is regarded as a measure of success.
Profit plays a significant role in a free enterprise economy. It is unthinkable to have a private enterprise economy without an element of profit. Profits provide the resources for expansion and encourage entrepreneurs to increase production.
Profits ensure that production is carried on efficiently and indicate which industries should expand and to what extent. The most important function of the profit is that it helps us to take the risk of uncertainty. The objective of every rational business firm is the maximisation of profits. Now, let us discuss various concepts of profit.