RISK THEORY OF PROFIT

BY
MAHESHKUMAR PATIL
NADER HAJIZADEH
RAZIEH JAHANDIDEH
ELNAZ ALASVAND
RISK THEORY OF PROFIT

• F. B. Hawley emphasized risk taking as the

function of the entrepreneur for which he needs
the inducement of profit.
• If risk is not properly rewarded nobody would be
willing to undertake risk. Higher the risk the
greater must be the possibility of profit.
Cont…
• Hawley held that profit is the reward for risk and
responsibilities that the undertaker subject
himself to replacement or depreciation is
calculated and provided for an item of cost.
• Obsolescence is not calculable because to
anticipate technical progress is difficult. But
even then it is counted as a cost.
Cont…
• Business risk and certainty are not provided for
in costs in the conventional sense.
• The entrepreneur bears these in anticipation of
profit. But for profit, nobody will bear these
risks. They are called staying in business.
• The greater the amount of risk involved in a
business higher is the expected profit necessary
to induce entrepreneur to bear risk.
RISK CURVE
DISCUSSION
• The situation is easily understood from the
conventional diagram.
• If the curve CD represents the relative importance
of successive agents of a series, or units of some
really fundable agent, then under perfect
competition every unit will get the product DE, and
a certain group E'E will get FDE'E.
• If now these EE' units combine so as to become
marginal as a group, they can get instead D'DE'E,
gaining D'DF over the former arrangement.
CONT…
• The owner of the group can prevent the substitution
of a (marginal) unit outside the group for any unit in
it, and so cause a larger product to be dependent on
the employment of the group than the aggregate
marginal products of its members.
• Similar agencies outside the combination will only get
the wage DE, and the surplus income received by our
consolidated block will come out of the shares of the
agencies with which it is combined, not out of an
increase in the price of the product to consumers.
CRITICISMS

• Prof. Carver said that profit accurse to the entrepreneur not

because he undertake risk, but because he avoids risk with
the use of his business ability.
• Profit is the reward for risk reduction instead of risk-taking.
• According to critics there is no direct relationship between
profit and risk-taking. In reality, many other factors besides
risk influence profit.
CONT…
• According to Knight, there are two types of risks
• (I) foreseeable risk
The former can be anticipated and provided
against through insurance. For example the risk
of fire in a factory can be covered through fire
insurance. The premium so paid may be makes
provision against it; it creases to be risk.
CONT…
(II)Unforeseen risk

• Unforeseen risk on the other hand cannot be

foreseen by entrepreneur and as such they
cannot be covered through insurance.
• For example, the risk of commercial loss in
business is an unforeseeable risk or uncertainty
risk.
DISADVANTEGE
• It does not make distinction between known risk
and unknown risk.
• It has lot of criticism.
CONCLUSION
• The risk theory is not the a complete explanation
of profit although it must be admitted that
entrepreneurs undertake risks and expect
reward for doing so that a part of due their
earning is due to this element.
Objectives of a business firm
• Profits Maximization
• Staff Maximization
• Sales Maximization
• Growth Maximization
• Managerial Utility Maximization
Profits Maximization
Pro fits Max imi zat ion

• Profit maximization is always assumed to be the

most important objectives of any firm
• The aim should be earn satisfactory profits and
not maximum profit.
•  We show the firm producing 20 units of output, the
level of output where MR = MC.
• At that level of output the firm sells its product for 10
per unit.
• This means the firm's total revenue is 10 x 20 = 200.
At 20 units of output ATC = 7 so total cost is 20 x 7 =
140.
• So profit = TR - TC = 200 - 140 = 60. Or average
profit is 10 - 7 = 3 per unit, so profit is 20 x 3 =
60.
 
Staff Maximization

• Now a days business and corporation run by

professional manager, as there is the separation
from of ownership from control.
• The manager aims at maximization staff rather
than profit.
• When the firm possesses the degree of
monopoly in the market manager may tread of
some profits for an expansion in the size of the
staff.
Sales Maximization
• The notion that business firms is primarily
motivated by the desire to achieve the greatest
possible level of sales, rather than profit
maximization

• For firms operating in relatively competitive

markets, facing relative fixed prices, and
relatively constant average cost, then increasing
sales is bound to increase profits, too.
Growth Maximization
• Corporate managers try to maximize the rate of
growth of output or total sales revenue rather
than maximizing profit.

• The managers pursue multiple goals in which

along with sales maximization the objective of
achieving the highest possible growth of output
is paramount.
Managerial Utility Maximization
• The utility of managers will be increased if their
status improves by an enlargement of staff
expenditures, as this shows ability to manage, or
if managerial salaries and profits are higher than
an acceptable minimum level.
Being a good employer
• A happy work force can contribute to a firm
through lower turnover , productivity
and higher profits.

• There is positive relationship between better

employers and profits.