Economics » Factors of Production » Determination of Wages, Interest, Profits

Profits

Profit is the reward an entrepreneur receives. Profit occurs when a firm’s revenue is greater than its costs. The following factors determine profitability:

  1. The Degree of Competition: If a firm has monopoly power, then it has little competition. Therefore, demand will be very inelastic. This enables the firm to increase profits by increasing the price. If the market is very competitive, then profit will be lower. This is because consumers would only buy from the cheapest firms.
  2. The Strength of Demand: Profits generally have a positive relationship with demand, i.e. as the demand for the goods/services of a particular firm rises, the profits made by that firm also increase, and vice-versa.
  3. The State of the Economy: If there is economic growth, then there will be increased demand for most products and this will lead to an increase in profits, and vice-versa.
  4. Substitutes: The availability of substitutes of a product affects the demand of that product. If the substitutes of a certain product are expensive, this will lead to a rise in the demand for that product and this will, in turn, increase profits of the firms producing or selling the product; and vice-versa.
  5. Relative Costs: An increase in costs will decrease profits; this could include labour costs, raw material costs, cost of rent, etc. Also, a reduction in costs will increase profits.

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