The role of profit in a market economy
- It induces risk taking:-Normal profit is necessary to induce persons to accept, the risks of business uncertainties.
- It indicates the strength of an industry:-High profits indicate the products are popular with the consumers.
- Indicates popularity of products:- High profits indicate the products are popular with the consumers and is an indication that more factors should be brought into the industry to expand the output to meet consumers demand and vice versa.
- Encourage high output-Super normal profits encourage firms to increase production of goods. Profits act as inducement to firms to produce more goods.
- Provides resources for expansion:-When an industry makes supernormal profits, it can secure the necessary factors for expansion as it can be used to provide an additional capital by re-investing it back into the business. Profits also allow expanding firms to offer high rewards to attract factors. In this way, resources are moved according to the wishes of the consumers,
- Encourage research and innovations:-Profits enable firms to get substantial resources to engage in research, which leads to improvements in productivity of the firms and quality of the products.
- Promote efficiency in production:- In a perfectly competitive industry, a firm making the largest profits is the one whose costs are the lowest. It will have an incentive to expand production and if necessary, can afford to pay for more factors in order to increase output. Thus, the level of profit acts as a measure of efficiency of firms in the economy.
- Efficient allocation of resources:-Resources are always directed towards production process which offers the highest profit levels and away from the venture that offer less profit.