Abstract
This chapter intends to make a detailed overview of the theory of profit. Economic profit theory should answer many questions, but the debate on this subject is still lit, and this reflects a sense of uncertainty and stalemate that characterizes all the literature on it. Profit has always been a multidimensional concept, which does not fall into one economic discipline. Besides having various basic arguments, profit is also a source of numerous studies and business techniques, which are often outside of simple accounting rules. The evolution of knowledge of business, finance, and economics has allowed an increase in previous studies on the subject of profit. Firm and its management have become, over the years, the main focus of managerial analysis, assuming relevance that is both increasingly global and interdisciplinary.
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Notes
- 1.
In fact, profit can no longer be considered as a residual variable, that is, defined as the residual amount after having cleared the proceeds from all the negative (operational, structural, and economic) components of the enterprise; it should be defined as other management objectives within the business context.
- 2.
In the continuation of the work, I will have an overview of the most important and relevant business theories, such as those of Adam Smith, Ricardo, Mill, and Karl Marx.
- 3.
Division of labor is a key topic in economic theories and generally involves all human organizations, from small communities, such as the family, to the largest multinational corporations. Work is one of the factors of productivity, and its organization plays an essential role in the functioning and evolution of any type of society. In general, the division of labor increases average work productivity, but can only be applied extensively if it is favored by market expansion.
- 4.
Becker, G. S., & Murphy, K. M. (1992). The division of labor, coordination costs, and knowledge. The Quarterly Journal of Economics, 107(4), 1137–1160.
- 5.
Kirzner, I. M. (1979). Perception, opportunity, and profit. University of Chicago Press, Chicago.
- 6.
Stevenson, H. H. (1983). A perspective on entrepreneurship (Vol. 13). Cambridge, MA: Harvard Business School.
- 7.
Sexton, D. L. (1986). Role of entrepreneurship in economic development. Entrepreneurship, intrapreneurship, and venture capital, 27–39.
- 8.
The concept of the economy (cost-effectiveness) summarizes the company’s long-term ability to efficiently utilize its resources by effectively achieving its goals.
- 9.
Che, J., & Qian, Y. (1998). Insecure property rights and government ownership of firms. The Quarterly Journal of Economics, 113(2), 467–496.
- 10.
Alchian A., Uncertainty, Evolution and Economic Theory, Journal of Political Economy, no. 3, 1950.
- 11.
That is, the remuneration of the entrepreneur if he takes his job within the firm.
- 12.
See note 11.
- 13.
According to the author, the nature of the profit as composite income would reconnect to the disappearance of the figure of the classical entrepreneur following the affirmation of the large corporation.
- 14.
Langlois, R. N., & Robertson, P. L. (1995). Firms, markets and economic change (Vol. 136). London: Routledge.
- 15.
Considered by Joseph Schumpeter as “the greatest of all economists”, Leon Walras was the father of the first complete wording of the theory of general economic equilibrium.
- 16.
Marx, K. (1910). Value, price, and profit. CH Kerr & Company.
- 17.
Smith A., Wealth of Nations, 1776.
- 18.
Oi, W.Y. (1962). Labor as a quasi-fixed factor. Journal of political economy, 70(6), 538–555.
- 19.
There are several studies on the origins and interpretations of capitalism. According to some, the historical roots of the capitalist economy are to be found in long-distance business and in the activities of the financial centers of the middle ages and of the European Renaissance, which led to the emergence of capitalism as a dominant system from the sixteenth century. Other interpretations—such as that provided by classical economists—link capitalism to the industrial revolution of the eighteenth century, with the fence of lands, the creation of an independent labor market, the birth of manufactures and a capitalist production, capable of using the technological change of the era, drastically accelerating growth and consolidating the power of the bourgeoisie.
- 20.
Ricardo D., On the principles of political economy and taxation, 1817.
- 21.
That is a sort of price of scarcity due to the limited fertility and better-localized markets than the markets.
- 22.
It is Karl Marx who in the Third Book of Capital attributes the crisis of the capitalist system to the law of the tendency of the profit rate, or to the natural tendency of the economic system (based on the exploitation of surplus labor and surplus value) to see the ratio between surplus value and capital, or profit.
- 23.
See n.7.
- 24.
Lionel Robbins was an English economist known for his contributions to economic theories, derived from Marshallian bases. He is considered one of the greatest exponents of Marginalist theory. Robbins became famous in the academic environment for his economics definition: “Economics is the science that studies human behavior when, given a ranking of goals, choices on alternative means of using scarce resources have to be made.”
- 25.
Stuart Mill J., Principles of Political Economy, With Some of Their Applications to Social Philosophy, abridged with an introduction by Stephen Nathanson, Hackett Publishing Company, 2004.
- 26.
Marx deepens the relationship between exploitation and crisis in his major work, capital, whose goal is not “simply” to explain the functioning mechanisms of capitalism but also to criticize the mystified representations developed by economists (from which the subtitle Criticism of Political Economy).
- 27.
Unlike classical economists, Marx makes a clear distinction between workforce and labor. The workforce is the set of physical and intellectual abilities employed by workers in the production process. It differs from the labor actually delivered because it represents only the ability to work, which results in actual work only when the production process starts.
- 28.
The workforce is itself a freely available commodity on the market.
- 29.
Marx K., Capital, vol. III. 1894.
- 30.
“The surplus-labor consists of […] the surplus of the total amount of work incorporated in the commodity with respect to the amount of work paid that the commodity contains” (Capital, Book III, 68).
- 31.
Piero Sraffa, The Laws of Returns under Competitive Conditions, The Economic Journal, XXXVI, 1926, pp. 535–550.
- 32.
According to Bawerk, capital is not an original factor in production, such as land and work, but it is their backwardness. Its value, however, should not be measured on the basis of work and land used in the past, but rather of the ability to produce goods in the future.
- 33.
Fisher, I. (1930). The theory of interest. New York, 43.
- 34.
The “perfect” method, described in Ricossa (1986, p. 69), implies (1) the definition of an ideal situation (which in the case of these pages is the neoclassical competitive equilibrium), (2) the diagnosis of the separates itself from perfection (usually a market failure), and (3) the economic policy intervention.
- 35.
Alfred Marshall wanted to merge theory and historical knowledge to understand the complex causes that work in economic life. He thus designed to bring evolutionary into the economic discourse following the road indicated by Hebert Spencer. This combination of needs represented the peculiar aspect of Marshall’s design, which characterized him in the Marginalist revolution.
- 36.
The Austrian School argues that the only valid economic theory should derive logically from the basic principles of human action. In addition to its formal approach to theory, often called praxeology, the school has always preached an interpretative approach to history. The “praxeological” method allows deriving the laws of the economy valid for every human action, while the interpretative approach deals with individual historical events. The major contributions of the Austrian School in Economics are: (a) the theory of price distribution; (b) the emphasis on the convenient nature of each choice; (c) the theory developed by Hayek and von Mises on the economic cycle, also referred to as the Austrian economic cycle, which highlights the expansion of credit due to monetary policy and the fall in interest rates; (d) the Hayekian concept of intertemporal equilibrium; and (e) the view of Hayek and Von Mises of the price as an index of scarcity.
- 37.
Ferguson, C. E. (2008). The neoclassical theory of production and distribution. Cambridge Books.
- 38.
On the importance of profit as an element that connotes the capitalist economic model, see Sen, A., Goals, commitment, and identity, JL Econ. & Org., (1), 341, 1985.
- 39.
In terms of production, profit “is the entity that, over time, increases the company’s availability, covered that is all production costs. It stems from an activity of producing only when it is organized in such a way as to be profitable”; see Del Punta V., Profit and Maximization: Closure to a Study Conference, Economic Policy Review no. 10, 1969.
- 40.
Production logic appears to be the driving force behind the evolution of the concept of risk from a static field, whereby the risk is present in any economic environment, in a dynamic environment, where the risk tends to assume the meaning of uncertainty of result due to environmental economic mutations. The economic theory of profit is inspired by the criterion for which every factor in production is remunerated for the contribution made. If these contributions are added to the initiative and the organization (which makes it possible to overcome the risk and uncertainty elements) and the costs are attributed to the entrepreneur, the latter should also be attributed its benefits in the form of profit.
- 41.
For a sample of approaches to understanding the limits to the firm, see Arrow (1974), Williamson (1987, Chapter 6), and Klein (1996). On the internal organization of the firm—Coase’s third question—see Argyres and Mayer (2007). The economics literature on internal organization has tended to draw primarily on agency theory, not transaction cost economics.
- 42.
Ronald Coase’s landmark 1937 article, The Nature of the Firm, framed the study of organizational economics for decades. Coase asked three fundamental questions: Why do firms exist? What determines their boundaries? How should firms be organized internally? To answer the first question, Coase famously appealed to “the costs of using the price mechanism”, what we now call transaction costs or contracting costs, a concept that blossomed in the 1970s and 1980s into an elaborate theory of why firms exist (Alchian and Demsetz 1972; Williamson 1975, 1979, 1985; Klein et al. 1978; Grossman and Hart, 1986). The second question has generated a huge literature in industrial economics, strategy, corporate finance, and organization theory. “Why”, as Coase (1937, pp. 393–394) put it, “does the entrepreneur not organize one less transaction or one more?” In Williamson’s (1996, p. 150) words, “Why can’t a large firm do everything that a collection of small firms can do and more?” As Coase recognized in 1937, the transaction-cost advantages of internal organization are not unlimited, and firms have a finite “optimum” size and shape.
- 43.
Whether the firms will integrate thus depends on the comparative costs and benefits of contracting, not on the underlying production technology. Indeed, if contracting costs are low, the related diversifier may actually compete at a disadvantage relative to the single-business firm, because the diversified firm faces the additional bureaucratic costs of low-powered incentives, increased complexity, and so on (Williamson 1985).
- 44.
The problems and costs of measurement pervade and significantly affect all economic transaction. Errors of measurement are too costly to eliminate entirely. The value of equally priced items will differ, then, and people will spend resources to acquire the difference. Such resource expenditure is wasteful, and it is hypothesized that exchange parties will form such contracts and engage in such activities that reduce this kind of resource use. See Barzel Y., Measurement Cost and the Organization Markets, Journal of Law and Economics, vol. 25, n.1 (1982).
- 45.
The served market is that segment of the total market that the firm actively attempts to serve. It is difficult to define, but the concept is essential to the measurement of variables such as relative and absolute market share and growth rate. It is therefore imperative that this task is undertaken creatively before embarking on precise strategy formulation.
- 46.
This approach defines the firm as a governance structure that is coordinated by a hierarchical authority (Williamson 2002). Williamson considers authority as the heart of the employment relationship individuals have with the firm.
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Magni, D. (2019). Theory of Profit. In: New Perspectives of Profit Smoothing. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-21286-5_1
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