Hubbry Logo
Profit (economics)Profit (economics)Main
Open search
Profit (economics)
Community hub
Profit (economics)
logo
8 pages, 0 posts
0 subscribers
Be the first to start a discussion here.
Be the first to start a discussion here.
Profit (economics)
Profit (economics)
Profit (economics)
View on Wikipedia
from Wikipedia
This article is about profit in economics and political economy. For profit in accounting and business, see Profit (accounting).

Part of a series on
Capitalism
Concepts
Systems
Theories
Ideologies
Origins
Development
Intellectuals
Related topics
Part of a series on
Economics
Principles of Economics
Tools and methodology
Economic theory

Empirical methods

Prescriptive and policy

Branches and subfields
Applications
Difference between how accountants and economists view a firm

In economics, profit is the difference between revenue that an economic entity has received from its outputs and total costs of its inputs, also known as "surplus value".[1] It is equal to total revenue minus total cost, including both explicit and implicit costs.[2]

It is different from accounting profit, which only relates to the explicit costs that appear on a firm's financial statements. An accountant measures the firm's accounting profit as the firm's total revenue minus only the firm's explicit costs. An economist includes all costs, both explicit and implicit costs, when analyzing a firm. Therefore, economic profit is smaller than accounting profit.[3]

Normal profit is often viewed in conjunction with economic profit. Normal profits in business refer to a situation where a company generates revenue that is equal to the total costs incurred in its operation, thus allowing it to remain operational in a competitive industry. It is the minimum profit level that a company can achieve to justify its continued operation in the market where there is competition. In order to determine if a company has achieved normal profit, they first have to calculate their economic profit. If the company's total revenue is equal to its total costs, then its economic profit is equal to zero and the company is in a state of normal profit. Normal profit occurs when resources are being used in the most efficient way at the highest and best use. Normal profit and economic profit are economic considerations while accounting profit refers to the profit a company reports on its financial statements each period.

Normal profit = Total revenue – Total costs
Normal profit = Revenues – Total costs
Normal profit = Revenues – (Implicit costs + Explicit costs)

Economic profits arise in markets which are non-competitive and have significant barriers to entry, i.e. monopolies and oligopolies. The inefficiencies and lack of competition in these markets foster an environment where firms can set prices or quantities instead of being price-takers, which is what occurs in a perfectly competitive market.[4] In a perfectly competitive market when long-run economic equilibrium is reached, economic profit would become non-existent, because there is no incentive for firms either to enter or to leave the industry.[5]

Competitive and contestable markets

[edit]
Only in the short run can a firm in a perfectly competitive market make an economic profit.

Companies do not make any economic profits in a perfectly competitive market once it has reached a long run equilibrium. If an economic profit was available, there would be an incentive for new firms to enter the industry, aided by a lack of barriers to entry, until it no longer existed.[6] When new firms enter the market, the overall supply increases. Furthermore, these intruders are forced to offer their product at a lower price to entice consumers to buy the additional supply they have created and to compete with the incumbent firms (see Monopoly profit § Persistence).[7][8][9][10] As the incumbent firms within the industry face losing their existing customers to the new entrants,[11] they are also forced to reduce their prices. Therefore, increased competition reduces price and cost to the minimum of the long run average costs. At this point, price equals both the marginal cost and the average total cost for each good production.[7][8] Once this has occurred a perfect competition exists and economic profit is no longer available.[12] When this occurs, economic agents outside the industry find no advantage to entering the market, as there is no economic profit to be gained. Then, the supply of the product stops increasing, and the price charged for the product stabilizes, settling into an equilibrium.[7][8][9]

The same is likewise true of the long run equilibria of monopolistically competitive industries, and more generally any market which is held to be contestable. Normally, a firm that introduces a differentiated product can initially secure temporary market power for a short while (See Monopoly Profit § Persistence). At this stage, the initial price the consumer must pay for the product is high, and the demand for, as well as the availability of the product in the market, will be limited. In the long run however, when the profitability of the product is well established, and because there are few barriers to entry,[7][8][9] the number of firms that produce this product will increase. Eventually, the supply of the product will become relatively large, and the price of the product will reduce to the level of the average cost of production. When this finally occurs, all economic profit associated with producing and selling the product disappears, and the initial monopoly turns into a competitive industry.[7][8][9] In the case of contestable markets, the cycle is often ended with the departure of the former "hit and run" entrants to the market, returning the industry to its previous state, just with a lower price and no economic profit for the incumbent firms.

Economic profit can, however, occur in competitive and contestable markets in the short run, since short run economic profits attract new competitors and prices fall. Economic loss forces firms out of the industry and prices rise till marginal revenue equals marginal cost, then reach long run equilibrium. As a result of firms jostling for market position. Once risk is accounted for, long-lasting economic profit in a competitive market is thus viewed as the result of constant cost-cutting and performance improvement ahead of industry competitors, allowing costs to be below the market-set price.

Uncompetitive markets

[edit]
A monopolist can set a price in excess of costs, making an economic profit (shaded). The above picture shows a monopolist (only one firm in the industry/market) that obtains a (monopoly) economic profit. An oligopoly usually has "economic profit" also, but usually faces an industry/market with more than just one firm (they must share available demand at the market price).

Economic profit is much more prevalent in uncompetitive markets such as in a perfect monopoly or oligopoly situation, where few substitutes exit. In these scenarios, individual firms have some element of market power. Although monopolists are constrained by consumer demand, they are not price takers, but instead either price or quantity setters. Due to the output effect and the price effect, marginal revenue for uncompetitive markets is very different from marginal revenue for competitive firms.[13] In the output effect, more output is sold, quantity sold is higher. In the price effect, this reduces the prices firms charge for every unit they sell, and cut in price reduces revenue on the units it was already selling. Therefore, in uncompetitive market, marginal revenue is less than its price. This allows the firm to set a price which is higher than that which would be found in a similar but more competitive industry, allowing the firms to maintain an economic profit in both the short and long run.[7][8]

The existence of economic profits depends on the prevalence of barriers to entry, which stop other firms from entering into the industry and sapping away profits like they would in a more competitive market.[10] Examples of barriers to entry include patents, land rights, and certain zoning laws.[14] These barriers allow firms to maintain a large portion of market share due to new entrants being unable to obtain the necessary requirements or pay the initial costs of entry.

An oligopoly is a case where barriers are present, but more than one firm is able to maintain the majority of the market share. In an oligopoly, firms are able to collude and limit production, thereby restricting supply and maintaining a constant economic profit.[7][10][2] An extreme case of an uncompetitive market is a monopoly, where only one firm has the ability to supply a good which has no close substitutes.[14] In this case, the monopolist can set its price at any level it desires, maintaining a substantial economic profit. In both scenarios, firms are able to maintain an economic profit by setting prices well above the costs of production, receiving an income that is significantly more than its implicit and explicit costs.

Government intervention

[edit]

The existence of uncompetitive markets puts consumers at risk of paying substantially higher prices for lower quality products.[15] When monopolies and oligopolies hold large portions of the market share, less emphasis is placed on consumer demand than there would be in a perfectly competitive market, especially if the good provided has an inelastic demand. Government intervention in the form of restrictions and subsidies can also create uncompetitive markets.[16] Governments can also intervene in uncompetitive markets in an attempt to raise the number of firms in the industry, but these firms cannot support the needs of consumers as if they were born out of a profit generated on a competitive market basis.[17] [neutrality is disputed]

In a regulated industry, the government examines firms' marginal cost structure and allows them to charge a price that is no greater than this marginal cost. This does not necessarily ensure zero economic profit for the firm, but eliminates a monopoly profit.

Competition laws were created to prevent powerful firms from using their economic power to artificially create barriers to entry in an attempt to protect their economic profits.[8][9][10] This includes the use of predatory pricing toward smaller competitors.[7][10][2] For example, in the United States, Microsoft Corporation was initially convicted of breaking Anti-Trust Law and engaging in anti-competitive behaviour in order to form one such barrier in United States v. Microsoft. After a successful appeal on technical grounds, Microsoft agreed to a settlement with the Department of Justice in which they were faced with stringent oversight procedures and explicit requirements[18] designed to prevent this predatory behaviour. With lower barriers, new firms can enter into the market again, making the long run equilibrium much more like that of a competitive industry, with no economic profit for firms and more reasonable prices for consumers.

On the other hand, if a government feels it is impractical to have a competitive market—such as in the case of a natural monopoly—it will allow a monopolistic market to occur. The government will regulate the existing uncompetitive market and control the price the firms charge for their product.[8][9] For example, the old AT&T (regulated) monopoly, which existed before the courts ordered its breakup, had to get government approval to raise its prices. The government examined the monopoly's costs, and determined whether or not the monopoly should be able raise its price. If the government felt that the cost did not justify a higher price, it rejected the monopoly's application for a higher price. Though a regulated firm will not have an economic profit as large as it would in an unregulated situation, it can still make profits well above a competitive firm in a truly competitive market.[9]

Maximization

[edit]
Main article: Profit maximization

It is a standard economic assumption (although not necessarily a perfect one in the real world) that, other things being equal, a firm will attempt to maximize its profits.[19] Given that profit is defined as the difference in total revenue and total cost, a firm achieves its maximum profit by operating at the point where the difference between the two is at its greatest. The goal of maximizing profit is also what leads firms to enter markets where economic profit exists, with the main focus being to maximize production without significantly increasing its marginal cost per good. In markets which do not show interdependence, this point can either be found by looking at these two curves directly, or by finding and selecting the best of the points where the gradients of the two curves (marginal revenue and marginal cost respectively) are equal.[14] In the real world, it is not so easy to know exactly firm's marginal revenue and the marginal cost of last goods sold. For example, it is difficult for firms to know the price elasticity of demand for their good – which determines the MR.[20] In interdependent markets, It means firm's profit also depends on how other firms react, game theory must be used to derive a profit maximizing solution.

Another significant factor for profit maximization is market fractionation. A company may sell goods in several regions or in several countries. Profit is maximized by treating each location as a separate market.[21] Rather than matching supply and demand for the entire company the matching is done within each market. Each market has different competitions, different supply constraints (like shipping) and different social factors. When the price of goods in each market area is set by each market then overall profit is maximized.

Other applications of the term

[edit]

The social profit from a firm's activities is the accounting profit plus or minus any externalities or consumer surpluses that occur in its activity. An externality including positive externality and negative externality is an effect that production/consumption of a specific good exerts on people who are not involved.[7][10][2] Pollution is an example for negative externality.

Consumer surplus is an economic indicator which measures consumer benefits.[7][10][2] The price that consumers pay for a product is not greater than the price they desire to pay, and in this case there will be consumer surplus.

For the supply side of economics, the general school of thought is that profit is meant to ensure shareholder yield. While it is the case that profits are a means for shareholder returns, it also fulfills other functions. A target surplus may secure long-term solvency in the event of facing potential adversity. Capital surplus may be used to finance investments with significant capital expenditures or charitable contributions. All in all, producer surplus concerns several factors of interest for a for-profit economic entity.[22][23]

See also

[edit]

Notes

[edit]

References

[edit]
[edit]
Revisions and contributorsEdit on WikipediaRead on Wikipedia

Profit (economics)

View on Grokipedia
from Grokipedia
In economics, profit is defined as the surplus obtained when a firm's total revenue exceeds its total economic costs, encompassing both explicit outlays such as wages and materials and implicit opportunity costs of invested capital and entrepreneurial effort. This measure, distinct from accounting profit which ignores opportunity costs, reflects true value creation by compensating for risk and alternatives forgone. Economic profit serves as a signal for resource reallocation, guiding capital toward productive uses in competitive markets where persistent positive profits attract entrants, eroding supernormal returns toward zero in long-run equilibrium. Profit functions as the core incentive in market economies, motivating innovation, efficient production, and risk-taking by entrepreneurs who bear uncertainty in pursuit of returns above normal compensation. Empirical analyses demonstrate that higher profitability correlates with increased market share and resource efficiency, fostering broader economic growth through reinvestment and competition. Studies further reveal a virtuous cycle wherein profits enable product innovation and capital investments, which in turn sustain profitability and expand output, underscoring profit's causal role in dynamic economic expansion rather than mere redistribution. While critics contend that innovation can occur without profit motives, evidence from market-oriented systems highlights profit's empirical superiority in driving sustained technological advancement and productivity gains over alternative frameworks lacking such incentives. In regulated or less competitive environments, however, profits may reflect barriers to entry rather than efficiency, prompting debates on antitrust measures to preserve competitive discipline.

Definitions and Distinctions

Accounting Profit

Accounting profit, also known as bookkeeping or financial profit, represents a firm's net income calculated by subtracting all explicit costs from total revenue. Explicit costs are direct, out-of-pocket monetary expenses, such as wages paid to employees, rent for facilities, purchases of raw materials, utilities, and depreciation of assets. This measure follows standard accounting principles and is reported on the income statement as the bottom-line profit after deducting operating expenses, interest, and taxes. The formula for accounting profit is straightforward: total revenue minus total explicit costs. For instance, if a manufacturing firm generates $500,000 in sales revenue and incurs $350,000 in explicit costs—including $150,000 in labor, $100,000 in materials, $50,000 in rent, and $50,000 in depreciation—the accounting profit would be $150,000. This calculation relies on historical data and accrual accounting methods, recognizing revenues when earned and costs when incurred, rather than strictly on cash flows. In economic analysis, accounting profit serves as a key indicator for financial reporting, taxation, and short-term performance evaluation, but it excludes implicit costs like opportunity costs of capital or owner time, potentially overstating profitability from an economic standpoint. Limitations include its focus on a single accounting period, vulnerability to manipulation through accounting choices (e.g., accelerated depreciation), and failure to account for the time value of money or alternative investment returns, which can mislead long-term decision-making. Despite these, it remains essential for compliance with regulatory standards and investor assessments, as positive accounting profit signals solvency and capacity to distribute dividends.

Economic Profit

Economic profit, also known as supernormal profit or pure profit, represents the residual return to a firm after for both explicit out-of-pocket costs and implicit opportunity costs associated with resource use. It is calculated as minus the sum of explicit costs (such as wages, rent, and materials) and implicit costs (such as foregone from alternative investments or the owner's time). The formula for economic profit is:
Economic Profit = Total Revenue - (Explicit Costs + Implicit Costs). For instance, if a firm generates $500,000 in revenue, incurs $300,000 in explicit costs, and faces $150,000 in implicit costs (e.g., the owner's salary from an alternative job), the economic profit is $50,000. This measure reveals whether a firm is truly covering the full cost of capital and entrepreneurship, unlike accounting profit, which ignores implicit costs and thus overstates viability. In competitive markets, positive economic profit signals inefficient resource allocation, prompting new entrants that erode such profits toward zero in long-run equilibrium, where price equals average total cost including opportunity costs. Negative economic profit, conversely, indicates resources are better deployed elsewhere, driving exit and reallocation. This dynamic ensures profits guide capital toward higher-value uses, as evidenced in neoclassical models where zero economic profit reflects efficient equilibrium. Empirical studies, such as those analyzing firm persistence, confirm that sustained economic profits are rare and often tied to barriers like innovation or scale, rather than systemic misallocation.

Normal and Supernormal Profits

Normal profit represents the threshold level of return that covers all economic costs, including both explicit outlays and implicit opportunity costs, resulting in zero economic profit. This level suffices to retain entrepreneurial resources in their current use, as it equals the returns available from alternative investments or occupations. For instance, if an entrepreneur forgoes a 10% return on capital elsewhere, normal profit must at least match that benchmark to prevent resource reallocation. In long-run equilibrium under perfect competition, firms earn precisely normal profit, as entry or exit adjusts supply until price equals average total cost, incorporating these opportunity elements. Supernormal profit, alternatively termed abnormal or pure profit, arises when total revenue surpasses total economic costs, generating positive economic profit beyond the normal return. This excess stems from factors such as temporary market imbalances, barriers to entry, or superior efficiency, allowing firms to capture rents not attributable to mere cost recovery. In short-run scenarios, even competitive firms may realize supernormal profits if demand surges outpace capacity adjustments, though such gains typically dissipate over time through new entrants bidding down prices. Empirical observations, such as elevated returns in concentrated industries, underscore how supernormal profits signal resource misallocation or innovation rewards, prompting causal shifts toward equilibrium via competition. The distinction hinges on economic versus accounting perspectives: normal profit embeds implicit costs often overlooked in balance sheets, while supernormal profit reveals true surplus value creation. Firms sustaining supernormal profits long-term, as in monopolistic structures, reflect persistent advantages like patents or scale economies, but these invite regulatory scrutiny or emulation, aligning with causal mechanisms of market discipline.

Theoretical Foundations

Classical Economics

In classical economics, profit is the remuneration accruing to owners of capital as the residual share of the total output after payments to labor (wages) and land (rents), grounded in the which attributes the source of value primarily to labor exertion. This distribution reflects the productive contributions of factors, with profit motivating the abstinence from consumption required to amass and deploy capital for production. Adam Smith articulated this in An Inquiry into the Nature and Causes of the Wealth of Nations (1776), defining the profit of stock as the net surplus from capital's employment after accounting for losses, wages of superintendence, and other deductions from gross receipts. He emphasized that profits must exceed sufficient compensation for occasional losses to sustain investment, and observed an inverse relation with wages: as capital stock expands, competition among employers raises wages while compressing profit rates. In advancing economies, Smith noted, high wages paired with low but steady profits enhance overall productivity and international competitiveness, as evidenced by historical interest rates—proxies for profits—declining from 10% under Henry VIII to 5% by Queen Anne's era. David Ricardo refined the theory in On the Principles of Political Economy and Taxation (1817), positing that the general profit rate equalizes across sectors through capital mobility and is anchored in agriculture, where diminishing returns on successively inferior lands elevate rents, leaving less for profits given fixed subsistence wages. Profits thus decline secularly as population growth demands more food production on marginal soils, squeezing the capitalist's share and foreshadowing a stationary state with near-zero profits, absent technological offsets or international trade expansions. John Stuart Mill synthesized these ideas in Principles of Political Economy (1848), affirming profit's role in capital accumulation to drive growth, while echoing Ricardo's concerns over falling rates but allowing for mitigation through progress in arts and emigration of surplus population to colonies offering higher returns. Profits, as the spur to saving and risk-bearing, underpin the self-regulating market mechanism, allocating resources via the "invisible hand" toward efficient production, though classical analysis highlighted inherent tensions between accumulation and distributional limits.

Neoclassical and Marginalist Approaches

The Marginal Revolution, occurring primarily in the 1870s through the independent works of William Stanley Jevons, Carl Menger, and Léon Walras, introduced marginal analysis as the cornerstone for understanding economic value and decision-making, including profit determination. This paradigm shift emphasized subjective utility and incremental choices over aggregate labor inputs, enabling firms to optimize profits by equating marginal revenue to marginal cost at the output level where additional production neither adds nor subtracts from total profit. Marginalism thus reframed profit not as a fixed surplus from production but as the outcome of agents responding to scarcity signals through marginal trade-offs, laying the groundwork for neoclassical microeconomics. Neoclassical economics, synthesizing marginalist insights with equilibrium analysis, views profit maximization as the behavioral axiom for firms, assuming rational actors select inputs and outputs to maximize the residual after covering all opportunity costs. In this framework, economic profit—total revenue minus explicit and implicit costs—tends toward zero in long-run competitive equilibrium, as free entry and exit drive returns to the normal level compensating factors like capital and labor at their opportunity costs. Short-run supernormal profits may arise from temporary advantages, such as technological edges or demand shifts, but these incentivize imitation until dissipated, ensuring resource allocation aligns with consumer valuations. A pivotal neoclassical contribution to profit theory is Frank Knight's 1921 distinction in Risk, Uncertainty, and Profit between insurable risk—quantifiable probabilities yielding predictable returns priced via markets—and true uncertainty, arising from unforeseeable changes where no probabilities can be assigned. Knight posited that entrepreneurial profits serve as the reward for bearing this irreducible uncertainty through judgmental decisions, such as innovation or market entry, rather than routine risk management, which is compensated separately via wages, interest, or insurance. This explains persistent profit differentials across firms not as market failures but as compensation for superior foresight amid causal complexities beyond statistical modeling. Empirical applications of neoclassical profit models, such as in production functions, derive factor demands from profit maximization, setting marginal products equal to factor prices to minimize costs for given outputs. While foundational for welfare theorems linking competitive profits to Pareto efficiency, the approach assumes perfect information and foresight, which Knightian uncertainty challenges, highlighting profits' role in dynamic adaptation over static equilibrium.

Heterodox Perspectives

In Marxian economics, profit originates from surplus value, defined as the excess value produced by workers beyond the cost of their labor power, which is appropriated by capitalists as unpaid labor. This theory posits that commodities exchange at values determined by socially necessary labor time, with wages covering only the reproduction of labor (necessary labor time), while the remainder constitutes surplus labor yielding profit. The rate of surplus value, calculated as surplus value divided by variable capital (wages), measures exploitation intensity, independent of constant capital like machinery, though the average profit rate falls as organic composition of capital rises due to diminishing surplus relative to total capital. Empirical validations draw from historical data on wage shares versus profit rates, but critics argue the labor theory of value overlooks demand-side factors and capital's role in productivity. Post-Keynesian approaches, particularly Michal Kalecki's framework, reject marginal productivity explanations, viewing aggregate profits as endogenously determined by investment decisions and the degree of monopoly power in pricing. Kalecki's equation derives total profits as capitalists' investment minus household saving from wages plus capitalists' non-investment spending, implying that effective demand from investment realizes profits rather than production costs alone dictating them. Firms set prices as a markup over prime costs (materials and wages), with the markup reflecting oligopolistic market structures and bargaining power, leading to profit shares stable yet responsive to capacity utilization and growth. This contrasts with neoclassical supply-driven distribution by emphasizing demand-led accumulation, supported by postwar data showing profit persistence amid varying productivity, though it assumes passive wage adjustments critiqued for ignoring labor agency. Sraffian economics critiques neoclassical profit as a return to marginal product, instead treating it as a residual claim determined residually after wages in a circular production system without marginalism. Piero Sraffa's model in Production of Commodities by Means of Commodities (1960) demonstrates that the profit rate inversely relates to the real wage rate, with distribution shares fixed by social conventions rather than factor contributions, rendering capital's marginal productivity indeterminate due to reswitching and aggregation issues in the Cambridge capital controversy. This approach revives classical surplus theories, where profits emerge from output exceeding subsistence needs, validated by input-output analyses showing multiple techniques yielding same rates at given wages, undermining equilibrium marginalism. Detractors note its static nature ignores dynamic entrepreneurship and uncertainty, limiting applicability to growth contexts. Austrian economists conceptualize profit not as a steady equilibrium return but as a transient reward for entrepreneurial foresight in allocating resources under uncertainty, dissipating through competition as knowledge diffuses. Ludwig von Mises and Israel Kirzner emphasize profit arising from arbitrage opportunities discovered via subjective judgments, distinct from interest (time preference) or rent, with no reliance on marginal productivity aggregates but on individual action and market processes. Unlike neoclassical maximization, Austrians view firms as pursuing profits through alertness to disequilibria, supported by historical cases like Schumpeterian innovation waves where pure profits emerge temporarily before imitation erodes them. This perspective critiques interventionist policies for distorting signals, as seen in business cycle theories linking artificial credit expansion to malinvestment and profit illusions. Empirical challenges include quantifying "alertness," yet it aligns with observed profit volatility in unregulated markets versus persistence under regulation.

Economic Functions of Profit

Resource Allocation and Efficiency

In market economies, profits function as price-mediated signals that direct scarce resources toward their most valued uses, promoting allocative efficiency by aligning production with consumer preferences. High profits in an industry indicate that the value created exceeds production costs, incentivizing entrepreneurs to invest capital, labor, and other inputs, thereby expanding output in response to unmet demand. Conversely, persistent losses signal resource misallocation, prompting firms to contract operations or exit, freeing resources for alternative, higher-value applications. This dynamic process fosters productive efficiency as well, as competition erodes supernormal profits, compelling firms to minimize costs through technological improvements and operational refinements to sustain viability. Under conditions approximating perfect competition, profit-maximizing behavior leads firms to produce where price equals marginal cost, ensuring resources are not wasted on low-value outputs. Empirical studies affirm that firms achieving positive economic profits—accounting for opportunity costs—demonstrate superior resource utilization, outperforming peers in total shareholder returns by 4.7% and EBITDA margins by 3%, reflecting effective allocation at the firm level. However, barriers to entry or market distortions can impede these signals, leading to inefficiencies such as resource hoarding in unprofitable sectors. In centrally planned systems lacking profit incentives, allocation relies on administrative directives, often resulting in surpluses of unwanted goods and shortages of essentials, underscoring the causal role of decentralized profit motives in achieving efficient outcomes. Overall, profit's signaling mechanism underpins the market's capacity for self-correcting resource flows, prioritizing empirical productivity over ideological prescriptions.

Incentives for Innovation and Growth

In economic theory, profits incentivize innovation by providing entrepreneurs and firms with the financial rewards necessary to undertake risky investments in research and development (R&D), new processes, and product improvements that enhance productivity and market position. Joseph Schumpeter's framework of creative destruction emphasizes that the profit motive drives entrepreneurs to introduce novel technologies and methods, displacing inefficient incumbents and fostering long-term economic expansion through waves of innovation. This process generates temporary supernormal profits—arising from first-mover advantages or patent protections—which recede under competition, compelling sustained innovative efforts to maintain viability. Empirical analyses confirm that profitability directly supports R&D expenditures, which in turn propel technological progress and growth. A 2024 study of Italian manufacturing firms demonstrated that retained profits enable higher R&D intensity, forming a virtuous cycle where innovations boost subsequent profit margins by an average of 2-3% through enhanced efficiency and market share. Cross-country panel data from 1960-2000 reveal a positive elasticity of approximately 0.15 between R&D stocks and GDP per capita growth, indicating that profit-financed innovations contribute significantly to aggregate output expansion without evidence of diminishing returns at moderate levels. Moreover, firm-level evidence shows that prior-year operating profits predict R&D outlays, with a one-standard-deviation increase in profitability associated with 5-10% higher innovation outputs, such as patents, underscoring profits' role in alleviating internal financing constraints. This incentive mechanism operates most effectively in competitive markets, where the threat of profit erosion by rivals accelerates the diffusion of breakthroughs, amplifying economy-wide growth. Historical data from post-World War II recoveries in Western Europe link profit liberalization—via reduced regulations—to a 1.5-2% annual uplift in total factor productivity growth, attributable to heightened entrepreneurial experimentation. In contrast, environments with persistent low or negative profits, such as heavily subsidized sectors, exhibit subdued innovation rates, as evidenced by stagnant patent filings in state-dominated industries compared to private counterparts. Overall, profits align private incentives with societal gains from growth by channeling resources toward high-potential ventures, though outcomes depend on institutional factors like property rights enforcement to secure innovation rents.

Compensation for Risk and Entrepreneurship

In economic theory, profit functions as remuneration for the assumption of business risks that cannot be diversified away or insured against, particularly those arising from entrepreneurial judgment under uncertainty. This perspective traces to early risk-bearing theories, where profit emerges as the supply price of entrepreneurship, compensating for the exposure to unpredictable outcomes in production and market conditions. Unlike wages or interest, which reward routine labor or capital provision under known probabilities, profits reward the residual claimant who absorbs variances from expected returns due to factors like demand shifts or technological disruptions. A foundational distinction underlies this compensation: measurable risk, amenable to probabilistic forecasting and hedging, versus uninsurable uncertainty, which defies quantification because future states are inherently unknowable. Economist Frank Knight formalized this in 1921, arguing that in competitive equilibrium, only uncertainty-bearing yields profit, as risks can be priced into contracts or insurance premiums, leaving no residual gain. Entrepreneurs, as uncertainty-bearers, exercise judgment in coordinating resources amid incomplete information, with profits reflecting the accuracy of such foresight rather than mere chance. Knight's framework implies that without this incentive, economic dynamism would stall, as agents avoid ventures lacking upside potential to offset downside exposure. Empirically, entrepreneurial activities command risk premia exceeding those of diversified portfolios, evidenced by elevated required returns in high-uncertainty sectors. For instance, private equity and entrepreneurial credit risk demand premia significantly above household or corporate debt equivalents, with market data from 1980–2019 showing entrepreneurial lending yields 4–6 percentage points higher to compensate for default volatility tied to business-specific shocks. Venture-backed firms, embodying acute entrepreneurial risk, exhibit failure rates over 70% within a decade, necessitating gross returns of 20–30% annually for investors to achieve net positives after losses, as documented in longitudinal studies of startup cohorts. Selection effects amplify this: risk-tolerant individuals self-select into entrepreneurship, bearing nondiversifiable idiosyncratic risks without commensurate wage equivalents, though aggregate data reveal no broad "entrepreneurial premium" in consumption equivalents due to sorting by preferences rather than market failure. These patterns affirm profit's role in equilibrating supply of risk capital, with deviations—such as bubbles or subsidies—distorting allocation toward low-judgment speculation.

Profit Maximization

Core Assumptions and Models

In neoclassical microeconomics, the profit maximization model assumes that firms act as rational agents seeking to optimize their economic profit, defined as the difference between total revenue (TR) from sales and total cost (TC) of production, expressed as π=TR(Q)−TC(Q)\pi = TR(Q) - TC(Q), where QQ denotes output quantity. The firm achieves this by selecting the output level where marginal revenue (MR, the additional revenue from one more unit) equals marginal cost (MC, the additional cost of one more unit), as derived from the first-order condition dπdQ=MR−MC=0\frac{d\pi}{dQ} = MR - MC = 0, ensuring that producing beyond this point would reduce profits. This calculus-based approach presumes continuous adjustability of inputs and outputs, perfect divisibility of factors, and a static, single-period framework without dynamic adjustments over time. Key underlying assumptions include complete and costless information about market demand, input prices, and production technologies, enabling the firm to accurately forecast revenue and cost functions. Firms are presumed to behave rationally, prioritizing profit over other objectives such as sales volume or managerial utility, with decision-makers having no principal-agent conflicts that might dilute this goal. In competitive markets, firms are price-takers, facing horizontal demand curves where MR equals the market price PP, leading to the rule P=MCP = MC at the optimum; in imperfect markets, the downward-sloping demand implies MR < P, requiring adjustments for market power. These models often invoke ceteris paribus conditions, holding external factors constant to isolate profit-determining variables. Extensions incorporate constraints like budget limits or technological frontiers, where firms solve constrained optimization problems using Lagrange multipliers to maximize π\pi subject to production functions f(K,L)≥Qf(K, L) \geq Q, equating marginal products to factor prices (e.g., MPL/w=MPK/rMP_L / w = MP_K / r). Short-run models fix some inputs (e.g., capital), focusing on variable inputs like labor, while long-run models allow full adjustment, potentially yielding zero economic profits under free entry in competitive equilibrium due to normal returns covering opportunity costs. Empirical tractability relies on these simplifications, though real-world deviations—such as incomplete information or bounded rationality—are acknowledged in critiques but foundational to deriving supply curves and efficiency benchmarks.

Empirical Evidence and Behavioral Critiques

Empirical studies on firm behavior often challenge the strict assumption of short-run profit maximization. A 2022 survey of small business owners found that a significant portion prioritize achieving an "adequate" level of profit over exhaustive maximization, citing constraints like limited information and managerial effort. Similarly, econometric analyses of firm-level data indicate that while growth positively influences profits, higher profits can constrain subsequent growth, suggesting managers balance multiple objectives rather than solely pursuing marginal profit gains. Longer-term tests provide mixed support for profit maximization. Research examining firm survival under market competition posits a "market selection hypothesis," where non-maximizing firms are hypothesized to fail, leading surviving firms to appear as if they maximize profits; however, direct empirical validations of this dynamic remain limited and contested, with some evidence of persistent deviations in regulated or oligopolistic sectors. A 1978 study testing growth versus profit objectives in firms found inconsistent alignment with pure profit maximization, particularly in industries with high entry barriers. Behavioral economics critiques emphasize bounded rationality as a core limitation of the profit maximization model. Herbert Simon's framework of "satisficing"—selecting the first acceptable alternative rather than optimizing—argues that decision-makers face cognitive constraints, incomplete information, and organizational complexities that preclude full maximization; empirical observations from firm decision processes, such as heuristic-based pricing and inventory management, support this over global optimization. Experimental and field studies further reveal that managers often exhibit disadvantageous inequality aversion or overconfidence biases, leading to choices that sacrifice marginal profits for perceived fairness or strategic slack. These critiques do not negate profit as a dominant motivator but highlight its approximation in practice. While neoclassical models assume perfect foresight and computation, real-world evidence from behavioral models incorporating prospect theory or level-k thinking demonstrates that firms achieve near-optimal outcomes through adaptive rules rather than continuous calculus-based adjustments. Academic sources advancing these views, often from behavioral paradigms, warrant scrutiny for potential overemphasis on anomalies at the expense of aggregate market discipline, yet the data consistently reveal deviations from idealized maximization.

Profits in Market Structures

Perfect and Contestable Competition

In perfect competition, a theoretical market structure characterized by a large number of buyers and sellers, homogeneous products, perfect information, and no barriers to entry or exit, individual firms are price takers and maximize profit where marginal revenue equals marginal cost, which coincides with price equaling marginal cost. In the short run, firms may earn positive economic profits if market price exceeds average total cost at the profit-maximizing output, as fixed factors prevent immediate adjustment; for instance, an increase in demand can raise price above average cost, yielding supernormal profits that cover opportunity costs plus a return. These profits signal resource reallocation, attracting new entrants who expand supply, which depresses price until, in the long run, economic profits dissipate to zero—meaning price equals the minimum long-run average cost, covering all explicit and implicit costs including a normal return on capital, but no excess. This equilibrium ensures allocative efficiency, as price reflects marginal cost, and productive efficiency, as firms operate at minimum average cost, though the model assumes no economies of scale beyond the firm level and ignores transaction costs. Empirical approximations to perfect competition, such as certain agricultural markets, show short-run profit fluctuations driven by weather or demand shocks, but long-run tendencies toward normal profits due to entry by farmers or investors; however, real-world frictions like transportation costs or government subsidies often prevent exact zero economic profit. The model's prediction of zero long-run economic profit rests on causal mechanisms of entry and exit responding to profit signals, promoting dynamic efficiency without persistent rents, though critics note it understates strategic behaviors absent in the idealized setup. Contestable market theory, developed by William Baumol and colleagues in 1982, extends competitive discipline to markets with fewer firms by emphasizing the threat of potential entry rather than actual numbers of competitors; a market is contestable if entry and exit costs are negligible, particularly sunk costs, allowing "hit-and-run" entrants to capture profits temporarily before incumbents respond. In such settings, incumbents, facing the risk of predatory pricing or market share loss by entrants, limit prices to average cost levels, yielding outcomes akin to perfect competition—zero economic profits in equilibrium—despite oligopolistic structures, as sustainable supernormal profits invite immediate challenge. This theory posits that low barriers, like minimal capital commitments or reversible investments, enforce Ramsey-optimal pricing (efficient resource allocation minimizing deadweight loss) even in natural monopolies, prioritizing exit ease over incumbent numbers. Applications include airlines in the 1980s deregulation era, where low sunk costs for routes enabled new carriers to contest incumbents, pressuring fares toward costs and eroding excess profits, though empirical tests show mixed results due to actual sunk costs like airport slots undermining pure contestability. Unlike perfect competition's reliance on atomistic firms, contestability highlights causal realism in potential competition constraining rents, but it assumes symmetric information and rapid response times, which often fail in practice, leading to persistent markups where sunk costs create incumbency advantages.

Monopoly, Oligopoly, and Barriers to Entry

In a monopoly, a single seller faces the market demand curve and maximizes profit by producing where marginal revenue equals marginal cost, typically setting price above marginal cost and earning positive economic profit if average total cost lies below price at that output level. This economic profit, represented as total revenue minus total economic costs including opportunity costs, persists in the long run because high barriers to entry prevent rivals from eroding it through competition. For instance, natural monopolies in utilities achieve this via economies of scale where average costs decline over the relevant output range, making replication inefficient. Oligopolies feature few interdependent firms, each recognizing rivals' reactions in pricing or output decisions, often modeled via Cournot quantity competition or Bertrand price rivalry. Profits typically exceed competitive norms due to mutual forbearance or collusion, though non-cooperative equilibria can yield outcomes closer to competition; explicit cartels like OPEC have historically sustained higher profits through output restrictions. In concentrated industries such as automobiles or airlines, firms earn supra-normal returns intermittently, bolstered by strategic investments in capacity or branding that deter entrants. Barriers to entry fundamentally enable profit persistence in these structures, categorized as structural (e.g., economies of scale or network effects), legal (e.g., patents or licenses), or strategic (e.g., predatory pricing threats). High sunk costs in capital-intensive sectors like telecommunications amplify these, as potential entrants risk unrecoverable losses if incumbents respond aggressively. Without such barriers, free entry would drive economic profits to zero, aligning with contestable market theory where even incumbents behave competitively under credible entry threats. Empirical analyses reveal persistent markups and profits in monopolized or oligopolistic markets, with U.S. data from 1980–2014 showing rising industry concentration correlating with elevated profit rates, particularly in tech and pharma sectors shielded by intellectual property. Panel studies of oligopolistic pricing confirm that repeated interactions sustain margins above costs, as firms prioritize long-term gains over short-term defection, though regulatory interventions can mitigate excesses. These patterns underscore causal links between market power and profitability, challenging assumptions of rapid erosion absent barriers.

Real-World Variations and Dynamics

In real-world markets, profit levels vary substantially across industries due to differences in competitive intensity, , and structural factors. Empirical analyses of U.S. firms show net profit margins of approximately 8.54%, but with wide dispersion: sectors often achieve returns on equity (ROE) above 30%, driven by scalable innovations and network effects, while cyclical industries like retail or report medians closer to 10-12%. For instance, in 2023, wholesale trade profits reached $290.5 billion, reflecting scale advantages, whereas faced margin compression from global pressures. Profit dynamics feature mean-reversion tempered by persistence, where temporary supernormal profits invite entry, eroding advantages, but high barriers—such as patents, regulatory approvals, or capital requirements—prolong elevated returns. Time-series studies estimate an average short-run profit persistence coefficient of 0.59 across firms, implying that about 59% of deviations from normal profits carry over annually, with full adjustment occurring over 5-10 years in moderately competitive settings. In pharmaceuticals, patent exclusivity sustains ROE above 20% by deterring imitation, whereas agriculture yields near-zero economic profits due to low entry costs and commoditization. Technological shifts and globalization introduce further variability; digital platforms exhibit rising markups (from 0.247 in the 1980s to higher levels by 2023) via winner-take-all dynamics, contrasting with traditional sectors where competition enforces convergence. Empirical evidence from U.S. manufacturing confirms profit rate convergence over decades, as entry and innovation dismantle incumbents' rents, aligning with causal mechanisms of resource reallocation.
Industry SectorAverage ROE (Recent Data)Key Driver of Variation
Technology33.60%Innovation barriers, scalability
Retail45.90%High competition, low margins despite volume
Aerospace/Defense11.94%Regulatory and capital barriers
Advertising11.85%Intense rivalry, low entry costs
These patterns underscore that while competition generally disciplines profits toward equilibrium, persistent structural asymmetries sustain deviations, influencing long-term resource flows.

Criticisms and Debates

Exploitation and Surplus Value Claims

The Marxist doctrine of surplus value asserts that profit emerges from the exploitation of wage labor, wherein workers generate more value through their labor than the wages they receive, with the difference—termed surplus value—appropriated by capitalists as unearned gain. This formulation, detailed in Karl Marx's Capital (Volume I, 1867), derives from the labor theory of value, which holds that a commodity's exchange value is determined by the average socially necessary labor time embodied in its production, independent of demand or utility. This framework has faced substantial refutation in economic theory, primarily for its reliance on the discredited labor theory of value. Mainstream economics, following the marginalist revolution of the 1870s, posits that value arises from subjective marginal utility and scarcity rather than labor input alone, rendering surplus value incoherent as prices reflect consumer valuations and opportunity costs, not embedded labor hours. Eugen von Böhm-Bawerk, in his 1896 critique Karl Marx and the Close of His System, contended that capitalists earn returns not through exploitation but via the "roundabout" nature of production: capital goods enable more efficient, time-extended processes that yield greater output, compensating owners for deferring consumption, bearing uncertainty, and coordinating factors beyond mere oversight of labor. Böhm-Bawerk demonstrated through numerical examples that assuming equal labor inputs across sectors fails to equalize profit rates without invoking arbitrary adjustments, exposing contradictions in Marx's transformation problem from values to prices of production. Empirically, claims of inherent exploitation falter against data on factor returns. In the United States, real hourly compensation for production workers tracked labor productivity closely from 1947 to 1973, advancing at 2.6% and 2.8% annually, respectively, consistent with wages reflecting marginal productivity in competitive labor markets rather than systematic underpayment. Subsequent divergences in aggregate series, often cited by proponents of exploitation narratives, diminish when accounting for total compensation (including benefits), shifts to high-skill labor, and deflator adjustments; for instance, using output per hour deflated by the same productivity-consistent price index restores a tighter correlation. Cross-industry evidence further aligns profits with risk exposure: systematic risk (beta) explains persistent differences in profitability, as investors demand premiums for bearing non-diversifiable uncertainty, per capital asset pricing models validated in equity markets since the 1960s. In competitive equilibrium, economic profits—above normal returns to capital—tend toward zero as entry erodes rents, undermining the notion of enduring surplus extraction; observed supernormal profits typically stem from temporary innovations or barriers, not labor coercion. Voluntary contracts in labor markets, where workers select employment based on alternatives, preclude exploitation as unfair advantage, as defined in philosophical analyses requiring vulnerability or duress absent in modern economies with mobility and unemployment benefits. While Marxist interpretations endure in heterodox scholarship, their empirical foundation lacks robustness against neoclassical and Austrian rebuttals grounded in revealed preferences and historical wage gains under capitalist expansion.

Profits, Inequality, and Social Welfare

Critics of profit-driven capitalism contend that high corporate profits exacerbate income inequality by enabling wealth concentration among executives, shareholders, and capital owners at the expense of wage earners. For example, research indicates that corporate tax reductions in U.S. states from 1970 to 2010 led to a statistically significant increase in the pretax income share of the top 1%, with effects persisting over three years, as lower taxes boosted executive compensation and capital returns relative to labor income. Similarly, analyses of large U.S. firms show that profit surges, stock market gains, and CEO pay growth between 2018 and 2022 outpaced median salary and employment increases, contributing to wider disparities. These claims posit that such dynamics undermine social welfare by prioritizing private gains over equitable distribution, potentially leading to reduced consumer spending and social instability. However, empirical evidence links profit-facilitating economic freedom—characterized by secure property rights, open markets, and minimal barriers to entrepreneurship—to substantial poverty alleviation, suggesting net positive effects on social welfare. Cross-country data from 1995 to 2019 reveal a robust negative association between economic freedom scores and poverty rates, with improvements in trade freedom and government integrity particularly effective in reducing poverty headcounts. Nations with higher economic freedom, enabling vigorous profit-seeking, exhibit faster GDP growth and job creation, which elevate absolute living standards even amid relative inequality; for instance, the Heritage Foundation's Index of Economic Freedom correlates freer economies with lower extreme poverty and higher prosperity metrics. This aligns with causal mechanisms where profits incentivize investment in productivity-enhancing technologies, yielding broader benefits like cheaper goods and expanded employment opportunities. The Kuznets hypothesis further contextualizes this relationship, positing an inverted U-shaped curve where inequality rises during early industrialization—fueled by profit-motivated capital accumulation and urban migration—but declines at higher income levels as education, skills diffusion, and institutional maturation spread gains. Simon Kuznets's 1955 analysis of historical data from developed economies supported this pattern, with initial inequality spikes giving way to compression and welfare improvements through rising per capita incomes. Modern extensions confirm that profit-driven growth in emerging markets, such as post-reform Asia, follows this trajectory, reducing absolute deprivation despite temporary Gini coefficient increases; global extreme poverty fell from 36% in 1990 to under 10% by 2015, largely attributable to market liberalization and profit incentives in China and India. While inequality metrics like the Gini coefficient may elevate in highly profit-oriented systems, social welfare—measured by health, education, and consumption access—advances, as relative disparities do not preclude absolute progress for the bottom quintiles.

Counterarguments and Empirical Rebuttals

Proponents of the labor theory of value, including Marxist interpretations, posit that profits arise from capitalists extracting surplus value from workers' labor beyond necessary subsistence, implying inherent exploitation. Empirical observations contradict this by demonstrating that real wages in market economies have risen substantially above subsistence levels, often tracking productivity gains. For instance, a National Bureau of Economic Research analysis across countries and over time found that average wage growth closely correlates with aggregate productivity growth, suggesting workers capture a significant share of output increases through higher compensation rather than fixed exploitation. This alignment holds when accounting for total compensation, including benefits, countering claims of systematic underpayment divorced from value created. Critics arguing that profit maximization exacerbates inequality at the expense of social welfare overlook evidence that profit-driven incentives foster innovation and investment, yielding broad welfare gains. Studies confirm a positive relationship between firm profitability, technological innovation, and subsequent economic growth, as profits fund research and development that enhance productivity across sectors. Cross-country data further reveal that higher degrees of economic freedom—facilitating profit retention and market allocation—correlate with lower poverty rates, with mechanisms including job creation and efficient resource use lifting absolute living standards. For example, nations scoring higher on economic freedom indices exhibit reduced extreme poverty, as profit motives drive entrepreneurship and competition that benefit lower-income groups through expanded opportunities, rather than redistributive stagnation. Assertions linking profits to diminished social outcomes, such as poorer health or welfare, lack robust causal support when examined empirically. Aggregate studies on income inequality and population health find little consistent association, with factors like overall growth—propelled by profits—proving more determinative for improvements in life expectancy and mortality rates. In contrast, restricted profit incentives, as in less free economies, hinder the innovation cycles that have historically reduced global poverty by over 80% since 1980, primarily through market-driven advancements. Thus, profits serve as a signal for value creation, empirically tied to systemic welfare enhancements rather than zero-sum extraction.

Measurement and Policy Considerations

Calculation Methods and Accounting Standards

Accounting profit, also termed net income or bookkeeping profit, is computed as total revenue minus explicit costs, adhering to established financial reporting frameworks such as U.S. Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). This measure focuses on monetary transactions recorded in financial statements, excluding non-cash opportunity costs. The calculation typically proceeds through stages on the income statement: gross profit equals revenue less cost of goods sold (COGS); operating profit subtracts selling, general, and administrative expenses from gross profit; and net profit deducts interest, taxes, depreciation, amortization, and non-operating items from operating profit. Under accrual accounting, mandated by both GAAP and IFRS, revenues are recognized when earned and expenses when incurred, irrespective of cash flows, to reflect economic performance more accurately than cash basis methods. In economics, profit derivation from first principles subtracts all opportunity costs—explicit outlays plus implicit forgone alternatives—from total revenue, yielding economic profit that signals resource allocation efficiency. Economic profit = total revenue - (explicit costs + implicit costs); a zero value indicates normal returns covering opportunity costs, positive values supernormal profits, and negative values inefficiency prompting exit from the activity. Unlike accounting profit, which often overstates viability by ignoring alternatives like foregone investment returns, economic profit integrates these for decisions on production sustainability.
AspectAccounting ProfitEconomic Profit
Costs SubtractedExplicit (monetary outflows only)Explicit + implicit (opportunity costs)
FormulaRevenue - explicit costsRevenue - (explicit + implicit costs)
PurposeFinancial reporting and taxation and assessment
Typical Value RelativeGenerally higher than economic profitLower or zero in competitive equilibrium
Accounting standards enforce uniformity: GAAP, overseen by the Financial Accounting Standards Board (FASB), prescribes detailed rules for revenue recognition (ASC 606) and expense matching, while IFRS, issued by the International Accounting Standards Board (IASB), emphasizes principles-based fair value and substance over form, leading to minor variances like inventory valuation (LIFO permitted under GAAP but not IFRS). Both frameworks require disclosure of profit components, though IFRS updates such as the forthcoming IFRS 18 (effective 2027) will refine presentation by categorizing expenses into operating, investing, and financing to enhance comparability. Empirical analyses confirm accounting profits exceed economic profits systematically due to omitted implicit costs, influencing investor interpretations and policy assessments.

Taxation, Regulation, and Distortions

Corporate income taxes directly reduce after-tax profits by levying rates on taxable earnings, typically ranging from 20-30% in OECD countries as of 2023, thereby altering firms' incentives for investment and risk-taking. Empirical studies indicate that higher corporate tax rates negatively correlate with business investment rates, though the sensitivity has diminished since the 2008 financial crisis due to factors like lower interest rates and increased intangible assets. The 2017 U.S. Tax Cuts and Jobs Act, which lowered the federal corporate rate from 35% to 21%, led to a substantial increase in domestic investment, confirming that tax reductions enhance capital formation and profitability signals. These taxes impose deadweight losses estimated at 5-10% of revenue raised, arising from distorted resource allocation where firms underinvest in marginal projects whose returns fall below the tax wedge. Corporate taxation also burdens labor and capital suppliers, with evidence suggesting workers bear a significant share through lower wages, further eroding the efficiency of profit-driven resource mobilization. In open economies, tax incidence shifts partially to consumers via higher prices, amplifying distortions beyond direct profit erosion. Regulations elevate compliance costs, which disproportionately affect smaller firms and erect barriers to entry, thereby sustaining supra-normal profits for incumbents in regulated sectors. For instance, entry regulations in product markets correlate with persistent profit margins among established firms, as higher regulatory burdens deter new competitors and reduce market contestability. Studies across countries show that costly licensing and procedural requirements hamper firm creation, particularly in high-entry industries, leading to reduced overall profitability and innovation. Regulatory accumulation distorts investment toward compliance over productive activities, slowing economic growth and misallocating resources away from profit-maximizing uses. Deregulatory efforts, such as those under the U.S. administration in 2017-2021, yielded compliance cost savings equivalent to 0.29% of annual GDP, illustrating how excessive rules suppress profit opportunities for efficient entrants. In sectors like finance and energy, stringent rules increase operational costs by up to 10-20% of revenues for affected firms, compressing margins and favoring large incumbents capable of absorbing fixed compliance burdens. Combined, taxation and regulation create compounded distortions, where tax-induced underinvestment interacts with regulatory barriers to amplify deadweight losses and entrench inefficient profit distributions. Empirical evidence from U.S. states and international panels underscores that easing both reduces these inefficiencies, fostering higher aggregate profits through enhanced competition and capital deployment.

References

  1. http://mba.tuck.dartmouth.edu/paradigm/back_issues/fall1999/glossary/economic_profit.html
  2. https://pressbooks.oer.hawaii.edu/principlesofmicroeconomics/chapter/7-1-explicit-and-implicit-costs-and-accounting-and-economic-profit/
  3. https://www.e-education.psu.edu/ebf200ank/node/123
  4. http://www2.harpercollege.edu/mhealy/eco211/lectures/costprod/cost.htm
  5. https://www.tutor2u.net/economics/reference/what-are-the-main-roles-of-profit-in-a-market-economy
  6. https://hbr.org/1975/01/market-share-a-key-to-profitability
  7. https://link.springer.com/article/10.1007/s40797-024-00281-7
  8. https://www.researchgate.net/publication/266870010_Profit_and_Economic_Growth
  9. https://growthecon.com/StudyGuide/ideas/incentives.html
  10. https://research-archive.org/index.php/rars/preprint/view/3304
  11. https://www.ftc.gov/system/files/documents/reports/market-firm-economic-performance-empirical-analysis/wp084.pdf
  12. https://www.investopedia.com/terms/a/accountingprofit.asp
  13. https://corporatefinanceinstitute.com/resources/accounting/explicit-costs/
  14. https://www.investopedia.com/ask/answers/033015/what-difference-between-economic-profit-and-accounting-profit.asp
  15. https://www.indeed.com/career-advice/career-development/how-to-calculate-accounting-profit
  16. https://courses.lumenlearning.com/suny-fmcc-microeconomics/chapter/explicit-and-implicit-costs-and-accounting-and-economic-profit/
  17. https://www.khanacademy.org/economics-finance-domain/microeconomics/firm-economic-profit/economic-profit-tutorial/a/explicit-and-implicit-costs-and-accounting-and-economic-profit-cnx
  18. http://www.competetowin.co.uk/know-how/finance/limitations-of-accounting-profit/
  19. https://studyfinance.com/accounting-profit/
  20. https://corporatefinanceinstitute.com/resources/economics/economic-profit/
  21. https://www.fathomhq.com/kpi-glossary/economic-profit
  22. https://www.omnicalculator.com/finance/economic-profit
  23. https://www.wallstreetprep.com/knowledge/economic-profit/
  24. https://www.indeed.com/career-advice/career-development/how-to-calculate-economic-profit
  25. https://socialsci.libretexts.org/Bookshelves/Economics/Introductory_Comprehensive_Economics/Economics_%28Boundless%29/09%253A_Production/9.03%253A_Economic_Profit
  26. https://uh.edu/energyinstitute/gurcan/eecon6.pdf
  27. https://www.econlib.org/using-opportunity-cost/
  28. https://fiveable.me/key-terms/ap-micro/economic-profit
  29. https://econ.berkeley.edu/sites/default/files/course-homepage/2020-02-06/lecture-notes/Lecture%25206%25202-6%2520Outline%2520and%2520Slides.pdf
  30. https://homework.study.com/explanation/economic-profit-affects-a-allocation-of-resources-and-the-level-of-resource-use-b-misallocation-of-resources-and-the-level-of-income-c-the-allocation-of-resources-but-not-the-level-of-resources-d-the-level-of-resource-use-but-not-the-allocation-of.html
  31. https://scholarworks.sjsu.edu/cgi/viewcontent.cgi?article=1038&context=econ_pub
  32. http://faculty.fortlewis.edu/walker_d/econ_262_-_notes_on_the_theory_of_the_firm.htm
  33. http://www.csun.edu/~lem50734/lecture_6.pdf
  34. https://www.economicshelp.org/blog/3181/economics/supernormal-profits/
  35. https://gacbe.ac.in/pdf/ematerial/18BEC43C-U5.pdf
  36. https://www.tutor2u.net/economics/reference/3-3-4-normal-profits-supernormal-profits-and-losses-edexcel
  37. http://www2.harpercollege.edu/mhealy/eco211f/lectures/costprod/costfr.htm
  38. https://www.savemyexams.com/a-level/economics/edexcel/a/17/revision-notes/3-business-behaviour-and-the-labour-market/3-3-revenues-costs-and-profits/normal-profits-supernormal-profits-and-losses/
  39. http://gesd.free.fr/garegnani84.pdf
  40. https://www.adamsmithworks.org/documents/chapter-ix-of-the-profits-of-stock
  41. https://www.econlib.org/library/Smith/smWN.html?chapter_num=12#aa49
  42. https://la.utexas.edu/users/hcleaver/368/368RicardoPrinCh6Profitstable.pdf
  43. https://epublications.marquette.edu/econ_fac/264/
  44. https://www.hetwebsite.net/het/essays/margrev/phases.htm
  45. https://libjournals.mtsu.edu/index.php/jfee/article/view/1475/1057
  46. https://economics.ucr.edu/wp-content/uploads/2019/11/04-09-04Michael-Bernstein.pdf
  47. https://eml.berkeley.edu/~webfac/card/e101a_s05/neoclassicalfirm.pdf
  48. https://www.econlib.org/library/Enc/NeoclassicalEconomics.html
  49. https://faculty.sites.iastate.edu/ahallam/files/inline-files/ProfitMaximization.pdf
  50. https://fraser.stlouisfed.org/files/docs/publications/books/risk/riskuncertaintyprofit.pdf
  51. https://fee.org/articles/frank-knight-s-risk-uncertainty-and-profit-100-years-later/
  52. https://news.mit.edu/2010/explained-knightian-0602
  53. https://nmiller.web.illinois.edu/documents/notes/notes5.pdf
  54. https://www.marxists.org/archive/vygodsky/unknown/surplus_value.htm
  55. https://www.cambridge.org/core/books/guide-to-marxs-capital-vols-iiii/rate-of-profit-and-the-rate-of-surplus-value-in-capital-vol-i-ch-9-section-3-and-vol-iii-parts-i-and-iii/B280EC3CF30AB7F3C38BE73081532CDA
  56. https://monthlyreview.org/articles/the-multiple-meanings-of-marxs-value-theory/
  57. https://www.tandfonline.com/doi/full/10.1080/01603477.2023.2242327
  58. https://www.levyinstitute.org/pubs/wp_697.pdf
  59. https://www.econstor.eu/bitstream/10419/300692/1/1897335237.pdf
  60. https://link.springer.com/chapter/10.1007/978-1-349-17142-2_6
  61. https://larspsyll.wordpress.com/2024/01/07/sraffian-economics-a-critique/
  62. https://link.springer.com/article/10.1007/s12113-005-1002-9
  63. https://www.pipelinersales.com/the-austrian-school-of-economics/core-tenets-of-the-austrian-school/
  64. https://mises.org/mises-wire/austrian-business-cycle-theory-explained
  65. https://media.neliti.com/media/publications/607773-the-importance-of-profit-in-economics-an-7d9eb76d.pdf
  66. https://hal.science/hal-04937328/document
  67. https://fortuna-advisors.com/wp-content/uploads/2023/02/Driving-outperformance-The-power-and-potential-of-economic-profit-JACF.pdf
  68. https://www.econlib.org/library/Enc/CreativeDestruction.html
  69. https://dash.harvard.edu/server/api/core/bitstreams/7312037d-2b2d-6bd4-e053-0100007fdf3b/content
  70. https://www.imf.org/external/pubs/ft/wp/2004/wp04185.pdf
  71. https://www.researchgate.net/publication/273029321_Profits_RD_and_innovation--a_model_and_a_test
  72. https://www.sciencedirect.com/science/article/pii/S004873331730104X
  73. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1424237
  74. https://www.jstor.org/stable/1882285
  75. https://lawliberty.org/book-review/risk-uncertainty-and-profit-100-years-later/
  76. https://www.nber.org/papers/w28134
  77. https://rcer.econ.rochester.edu/rcerpapers/rcer_500.pdf
  78. https://digitalcommons.cwu.edu/cgi/viewcontent.cgi?article=1122&context=cobfac
  79. http://www.sfu.ca/~akaraiva/profmax.pdf
  80. http://home.uchicago.edu/~vlima/courses/econ201/pricetext/ProfMax.pdf
  81. https://articles.outlier.org/what-is-profit-maximization
  82. https://www.yourarticlelibrary.com/economics/profit-maximisation-theory-assumptions-and-criticisms-economics/28998
  83. https://www.masterclass.com/articles/neoclassical-economics
  84. https://eml.berkeley.edu/~saez/econ2/firms.pdf
  85. https://cdn.mises.org/qjae8_4_3.pdf
  86. https://digitalcommons.georgiasouthern.edu/cgi/viewcontent.cgi?article=1279&context=sbr
  87. https://www.sciencedirect.com/science/article/abs/pii/S0954349X13000623
  88. https://academic.oup.com/restud/article-abstract/66/4/769/1556423
  89. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1467-6435.1978.tb00653.x
  90. https://www.nobelprize.org/uploads/2018/06/simon-lecture.pdf
  91. https://plato.stanford.edu/entries/bounded-rationality/
  92. https://deepblue.lib.umich.edu/bitstream/handle/2027.42/48694/494_ftp.pdf%253Bjsessionid%253D5EDA6974ED299A1C541EBF1C1B845711?sequence%253D1
  93. https://www.econstor.eu/bitstream/10419/260848/1/cesifo1_wp9718.pdf
  94. https://www.scielo.br/j/rep/a/MFCTjcbLPQgfM8Bmw4HXGBK/
  95. http://web.uvic.ca/~bettyj/203/instructor_notes_topic6.pdf
  96. https://www.sfu.ca/~friesen/park_7e_sm_ch12.pdf
  97. https://publishing.lib.umn.edu/openmicro/08_perfect_competition.html
  98. https://ogburn.org/economicsperfectcompetition.pdf
  99. https://www.stlouisfed.org/~/media/Education/Presentations/Kwan-Teaching-Market-Structures-2015-AP.pdf
  100. https://www.sfu.ca/~wainwrig/Econ400/Baumol-contestableMkts.pdf
  101. https://cdn.mises.org/qjae7_3_1.pdf
  102. https://www.sciencedirect.com/science/article/abs/pii/S0167268197000814
  103. https://www.rbnz.govt.nz/-/media/dcc3d9c80ba04efcbc10ed52b1e8f93a.ashx?sc_lang=en
  104. https://www.asil.org/insights/volume/1/issue/2/concept-market-contestability-and-new-agenda-multilateral-trading-system
  105. https://courses.lumenlearning.com/suny-microeconomics/chapter/illustrating-monopoly-profits/
  106. https://www.khanacademy.org/economics-finance-domain/ap-microeconomics/imperfect-competition/ap-monopolies-tutorial/v/economic-profit-for-a-monopoly
  107. https://courses.ems.psu.edu/ebf200/node/247
  108. https://socialsci.libretexts.org/Bookshelves/Economics/Environmental_and_Resource_Economics/An_Interactive_Text_for_Food_and_Agricultural_Marketing_%28Thomsen%29/07%253A_Imperfect_Competition_and_Strategic_Interactions/7.05%253A_Section_5-
  109. https://www.investopedia.com/terms/o/oligopoly.asp
  110. https://corporatefinanceinstitute.com/resources/economics/oligopoly/
  111. https://www.tutor2u.net/economics/reference/profits-and-entry-barriers-in-markets-explained
  112. https://www.economicshelp.org/microessays/markets/oligopoly-diagram/
  113. https://www.economicshelp.org/blog/glossary/normal-profit/
  114. https://www.project-syndicate.org/commentary/high-monopoly-profits-persist-in-markets-by-joseph-e--stiglitz-2016-05
  115. https://www.jstor.org/stable/2098579
  116. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2266051
  117. https://www.venasolutions.com/blog/average-profit-margin-by-industry
  118. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/roe.html
  119. https://csimarket.com/screening/index.php?s=roe
  120. https://www.statista.com/statistics/222122/us-corporate-profits-by-industry/
  121. https://www.sciencedirect.com/science/article/abs/pii/S0167718797000556
  122. https://www.alliancebernstein.com/corporate/en/insights/investment-insights/profits-and-persistence-the-secret-to-investing-for-long-term-growth.html
  123. https://www.tutor2u.net/economics/reference/how-and-why-do-profits-vary-in-different-industries
  124. https://www.ineteconomics.org/perspectives/blog/profit-inflation-is-real
  125. https://www.sciencedirect.com/science/article/abs/pii/S0165176501004256
  126. https://oll.libertyfund.org/pages/completion
  127. https://fee.org/articles/were-still-haunted-by-the-labor-theory-of-value/
  128. https://mises.org/mises-wire/labor-and-capitalist-exploitation-bohm-bawerk-and-close-marxs-system
  129. https://www.bls.gov/opub/ted/2011/ted_20110224.htm
  130. https://fredblog.stlouisfed.org/2023/03/when-comparing-wages-and-worker-productivity-the-price-measure-matters/
  131. https://www.jstor.org/stable/256274
  132. https://mises.org/podcasts/marx-and-marxism/eugen-von-boehm-bawerks-critique-karl-marx
  133. https://plato.stanford.edu/entries/exploitation/
  134. https://www.nber.org/system/files/working_papers/w24598/w24598.pdf
  135. https://webassets.oxfamamerica.org/media/documents/Corporate_Inequality_Framework.pdf
  136. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3911478
  137. https://www.heritage.org/index/pages/about
  138. https://www.aeaweb.org/aer/top20/45.1.1-28.pdf
  139. https://cepr.org/voxeu/columns/introducing-kuznets-waves-how-income-inequality-waxes-and-wanes-over-very-long-run
  140. https://www.nber.org/system/files/working_papers/w26428/w26428.pdf
  141. https://www.economicstrategygroup.org/wp-content/uploads/2019/12/Expanding-Economic-Opportunity-for-More-Americans-The-Link-Between-Wages-and-Productivity-Is-Strong.pdf
  142. https://www.sciencedirect.com/science/article/pii/S219985312400129X
  143. https://www.researchgate.net/publication/5021345_Poverty_and_Economic_Freedom_Evidence_from_Cross-Country_Data
  144. https://aier.org/article/only-economic-freedom-pulls-people-out-of-poverty/
  145. https://pmc.ncbi.nlm.nih.gov/articles/PMC2690209/
  146. https://innovation-entrepreneurship.springeropen.com/articles/10.1186/s13731-016-0061-9
  147. https://corporatefinanceinstitute.com/resources/accounting/accounting-profit/
  148. https://www.coursera.org/articles/accounting-profit
  149. https://www.wallstreetprep.com/knowledge/profit-loss/
  150. https://www.khanacademy.org/economics-finance-domain/ap-microeconomics/production-cost-and-the-perfect-competition-model-temporary/types-of-profit/v/economic-profit-vs-accounting-profit
  151. https://study.com/academy/lesson/how-to-calculate-economic-profit-definition-formula.html
  152. https://corporatefinanceinstitute.com/resources/accounting/accounting-profit-vs-economic-profit/
  153. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2006335
  154. https://www.iasplus.com/en/standards/ifrs/ifrs9
  155. https://assets.kpmg.com/content/dam/kpmgsites/xx/pdf/ifrg/2024/isg-first-impressions-presentation-and-disclosure-ifrs-18.pdf
  156. https://www.ey.com/content/dam/ey-unified-site/ey-com/en-gl/technical/ifrs-technical-resources/documents/ey-gl-applying-ifrs-a-closer-look-at-ifrs-18-07-2025.pdf
  157. https://www.upwork.com/resources/accounting-profit-vs-economic-profit
  158. https://www.oecd.org/content/dam/oecd/en/publications/reports/2023/07/how-does-corporate-taxation-affect-business-investment_bf34611b/04e682d7-en.pdf
  159. https://taxfoundation.org/blog/tcja-corporate-tax-economic-effects/
  160. https://www.nber.org/system/files/working_papers/w6173/w6173.pdf
  161. https://home.treasury.gov/system/files/131/wp-101.pdf
  162. https://www.econstor.eu/bitstream/10419/95465/1/55145931X.pdf
  163. https://link.springer.com/article/10.1007/s11151-020-09787-7
  164. https://www.sciencedirect.com/science/article/abs/pii/S0304405X06000936
  165. https://www.jec.senate.gov/public/_cache/files/2934db7f-fb68-42f7-a4e5-1d5101352268/dr.-mclaughlin-testimony.pdf
  166. https://www.whitehouse.gov/wp-content/uploads/2025/08/The-Economic-Benefits-of-Current-Deregulatory-Efforts.pdf
  167. https://regulatorystudies.columbian.gwu.edu/sites/g/files/zaxdzs4751/files/2022-10/regulatory_compliance_burdens_litreview_synthesis_finalweb.pdf
  168. https://www.aeaweb.org/articles?id=10.1257/pol.20150378
  169. https://www.nber.org/reporter/2023number3/how-do-corporate-taxes-affect-economic-activity
Add your contribution
Related Hubs
User Avatar
No comments yet.