Dr.

SHAKUNTALA MISRA NATIONAL REHABILITATION UNIVERSITY

Lucknow

Faculty of Law

RESEARCH PROJECT ON

[DOES GREATER PROFITABILITY INCREASE ECONOMIC WELFARE]

For

COURSE ON ‘PROFITABILITY vs. WELFARE: THE LEGAL’

CLASS: B.Com., LL.B (Hons.) 8th Semester

Submitted by

[Santosh Lakhmani]

[37]

Academic Session: 2019-20

Under the Supervision of

Ms. Vijeta Dua Tandon

Prof. in Law

Faculty of Law

Dr. Shakuntala Misra National Rehabilitation University

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 INDEX
S.NO TOPIC PAGE.NO REMARK

1. INTRODUCTION 4

2. CONCEPT OF PROFITABILITY 5

3. PROFIT & PROFITABILITY 6

4. BENEFITS OF PROFIT 7-8

5. COSTS OF HIGHER PROFIT 9 - 10

6. COSTS OF HIGHER PROFIT 11

7. THE ROLE OF PROFIT IN AN ECONOMY 12

8. CONCLUSION 13

9. BIBLIOGRAPHY 14

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 ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude to my teacher Ms. Vijeta Dua Tandon
who gave me the golden opportunity to do this wonderful project on the topic DOES
GREATER PROFITABILITY INCREASE ECONOMIC WELFARE, which also helped
me in doing a lot of Research and I came to know about so many new things I am really thankful
to them.
Secondly I would also like to thank my parents and friends who helped me a lot in finalizing this
project within the limited time frame.

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 INTRODUCTION

Profit is an excess of revenues over associated expenses for an activity over a period of
time. Terms with similar meanings include earnings, income, and margin. Lord Keynes
remarked that ‘Profit is the engine that drives the business enterprise’. Every business
should earn sufficient profits to survive and grow over a long period of time. It is the
index to the economic progress, improved national income and rising standard of
living. No doubt, profit is the legitimate object, but it should not be over emphasized.
Management should try to maximize its profit keeping in mind the welfare of the
society. Thus, profit is not just the reward to owners but it is also related with the
interest of other segments of the society. Profit is the yardstick for judging not just the
economic, but the managerial efficiency and social objectives also.

Attempting to apply the principles of welfare economics gives rise to the field of public
economics, the study of how government might intervene to improve social welfare.
Welfare economics also provides the theoretical foundations for particular instruments
of public economics, including cost–benefit analysis, while the combination of welfare
economics and insights from behavioral economics has led to the creation of a new
subfield, behavioral welfare economics.

The field of welfare economics is associated with two fundamental theorems. The first
states that given certain assumptions, competitive markets produce efficient outcomes;
it captures the logic of Adam Smith's invisible hand. The second states that given
further restrictions, any Pareto efficient outcome can be supported as competitive
market equilibrium. Thus a social planner could use a social welfare function to pick the
most equitable efficient outcome, and then use lump sum transfers followed by
competitive trade to bring it about. Because of welfare economics' close ties to social

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choice theory, Arrow's impossibility theorem is sometimes listed as a third fundamental
theorem.

CONCEPT OF PROFITABILITY

Profitability means ability to make profit from all the business activities of an
organization, company, firm, or an enterprise. It shows how efficiently the management
can make profit by using all the resources available in the market. According to
Harvard & Upton, “profitability is the ‘the ability of a given investment to earn a return
from its use.”

However, the term ‘Profitability’ is not synonymous to the term ‘Efficiency’.

Profitability is an index of efficiency; and is regarded as a measure of efficiency and
management guide to greater efficiency. Though, profitability is an important yardstick
for measuring the efficiency, the extent of profitability cannot be taken as a final proof of
efficiency. Sometimes satisfactory profits can mark inefficiency and conversely, a proper
degree of efficiency can be accompanied by an absence of profit. The net profit figure
simply reveals a satisfactory balance between the values receive and value given. The
change in operational efficiency is merely one of the factors on which profitability of an
enterprise largely depends. Moreover, there are many other factors besides efficiency,
which affect the profitability.

The concept of profit entails several different meanings. Profit may mean the
compensation received by a firm for its managerial function. It is called normal profit
which is a minimum sum essential to induce the firm to remain in business. Profit may
be looked upon as a reward for true entrepreneurial function. It is the reward earned by
the entrepreneur for bearing the risk. It is termed as supernormal profit analysis.

Profit may imply monopoly profit. It is earned by a firm through extortion, because of
its monopoly power in the market. It is not related to any useful specific function. Thus
monopoly profit is not a functional reward. Profit may sometimes be in the nature of a

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windfall. It is an unexpected reward earned by a firm just by mere chance, an
inflationary boom.

PROFIT & PROFITABILITY

Sometimes, the terms ‘Profit’ and ‘Profitability’ are used interchangeably. But in real
sense, there is a difference between the two. Profit is an absolute term, whereas, the
profitability is a relative concept. However, they are closely related and mutually
interdependent, having distinct roles in business.

Profit refers to the total income earned by the enterprise during the specified period of
time, while profitability refers to the operating efficiency of the enterprise. It is the
ability of the enterprise to make profit on sales. It is the ability of enterprise to get
sufficient return on the capital and employees used in the business operation.

As Weston and Brigham rightly notes “to the financial management profit is the test of
efficiency and a measure of control, to the owners a measure of the worth of their
investment, to the creditors the margin of safety, to the government a measure of
taxable capacity and a basis of legislative action and to the country profit is an index of
economic progress, national income generated and the rise in the standard of living”,
while profitability is an outcome of profit. In other words, no profit drives towards
profitability.

Firms having same amount of profit may vary in terms of profitability. That is why R. S.
Kulshrestha has rightly stated, “Profit in two separate business concern may be
identical, yet, many a times, it usually happens that their profitability varies when
measured in terms of size of investment”.

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 BENEFITS OF PROFIT

 Increased tax revenues

Higher company profit will lead to a rise in corporation tax revenues. This enables
the government to spend more on public services, such as health care, education and
welfare payments. Therefore, indirectly, the general taxpayer benefits from a rise in
company profit.

 However, corporation tax rates have been falling in recent years. In the UK
corporation tax rates have fallen to 19%. So only one-fifth of company profit is
shared with the general taxpayer.

 Also, large multinationals have become adept at avoiding corporation tax

through channeling profit through countries with the lowest tax regime. For
example, Google, Microsoft and Apple have set up in Ireland to gain from low
tax rates. Amazon has a high turnover in many EU countries, but it has used
registration in Luxembourg to reduce tax rates.

 Research and development

Higher company profit enables firms to invest more in research and

development. This can lead to better products in the long-term, which benefit
consumers. This investment in improvements enables greater dynamic efficiency.
It is important for industries which require significant investment and research.
For example, when record companies make a profit, they can afford to invest in

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 scouting new music groups and artists. Drug companies claim they need to make
a high profit to enable the development of new drugs.

 However, it is debatable what percentage of profit is reinvested in research and

development. If companies make more profit, they may just use it to pay higher
salaries to managers and higher dividends to shareholders. In this respect, firms
are not providing a social benefit but redistributing income from the rich to the
poor.

 Higher dividends for shareholders

Higher profit is good news for shareholders who will gain more dividends.
Indirectly workers with private pensions will see some benefit. As pension funds
will own shares in profitable companies.

 However, it is a very indirect benefit and those who benefit the most will be
those who are wealthy.

 Incentive effects

Profit is an important incentive to encourage people to invest, innovate and take

risks. A rise in profitability will encourage more entrepreneurs to take risks and
invest. This can lead to increased economic opportunities, new employment and
higher growth.

 Signal effect.

Profit helps signal where rising demand is. Industries which are very profitable
should attract new firms to enter the market and increase their investment. For
example, the profitability of mobile phones attracted more firms to enter and
expand their operations. This has led to rapid improvements in the quality of
technology.

 Savings. Profit can be used to create savings for a cyclical downturn and avoid
firms going bankrupt.

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 COSTS OF HIGHER PROFIT

 Profit at the expense of other objectives

Firms who maximize profits for shareholders may ignore long term objectives such as
investing in better infrastructure. Or they may seek to maximize profit by cutting
corners – e.g. not following environmental legislation. Higher profit doesn’t necessarily
reflect increase economic and social welfare. For example, it is more profitable to use
artificial chemicals to grow food, but this has had high costs to the environment and
long-term effects on human and animal health.

 Monopoly power

Profit is often the result of monopoly power. Monopolies can create bigger profits by
charging high prices. However, this is allocatively inefficient (price greater than
marginal cost) leading to a deadweight welfare loss. Furthermore, those who lose out
will be those on low incomes. The most profitable companies of this decade – Apple,
Google, Microsoft and Facebook all have a degree of monopoly power.

 Unused cash reserves

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 It is not true firms use profit to reinvest, some large tech firms have been so profitable
they have struggled to make use of their profit and they have seen large rises in cash
reserves which represent an unproductive use of money.

According to Moody – a rating agency, US non-financial companies held a total of

$1.7tn held on their balance sheets.

 Apple’s cash reserves are the largest with total cash reserves of $216bn, 93% of
which is overseas.
 The top five companies Apple, Microsoft, Alphabet, Cisco and Oracle had a total
of $504bn of cash by the end of 2015.
 Microsoft has $90 billion of cash reserves – 91% overseas (Forbes)
 Google’s $64.4 billion

 Profit can be used to create barriers to entry

With very high levels of profit, firms can invest in extra capacity (limit pricing) or buy
up suppliers and key reselling points.

 Increased inequality

Higher profitability will benefit a smaller share of the population who own shares.
Higher profit often represents a transfer from the consumer to the shareholder.

 Profit a result of monopoly power

Higher profit doesn’t necessarily translate into higher wages. Firms with monopoly
power are able to pay wages below the competitive equilibrium. In fact, profit may
increase due to falling real wages.

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 OTHER FACTORS TO CONSIDER

 How is the profit made?

If firms make profit from selling desirable goods, then consumers are gaining welfare
from purchasing the goods that they want. If a firm is making profit because it has
monopoly power, then consumers may be unhappy with the goods on offer. For
example, if a firm has monopoly from selling gas or electricity but it is also inefficient
and there is power cut, the consumers get the worst of both world’s high prices and low
quality of service.

 Diminishing marginal utility of wealth

If large companies become more profitable and take a bigger share of national income,
then it is likely to cause an increase in income and wealth inequality. This is because
company profit benefits a few rich shareholders more than average workers. However,
if a millionaire gains 10% extra income, the increase in living standards may be quite
low. If a worker pays high prices to a profitable firm, it may significantly eat into living
standards. (Diminishing marginal utility)

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  Ownership of the company

If a company is a co-operative, then an increase in profit will be shared by all the

workers, consumers and stakeholders. However, if it is a multinational plc, profit will
go to a small number of shareholders. For example, a developing economy may be very
poor, but a multinational company may invest in oil extraction. In this case, even if the
firm is very profitable, local people may see little return and increase in economic
welfare. If a company is nationalized and it makes more profit, then the profit will go to
government revenues. This enables the government to cut taxes or spend more on
public services.

THE ROLE OF PROFIT IN AN ECONOMY

Profit is the surplus revenue after a firm has paid all its costs. Profit can be seen as the
monetary reward to shareholders and owners of a business. In a capitalist economy,
profit plays an important role in creating incentives for business and entrepreneurs. For
an incumbent firm, the reward of higher profit will encourage them to try and cut costs
and develop new products. If an industry is profitable, it will encourage new firms to
enter. If a firm becomes unprofitable, it will either have to adapt and change or close
down. This profit motive can help increase efficiency, provide greater choice for
consumers and allocate resources according to consumer preferences.

However, profit can have a downside. To increase profits, firms may take action which
causes market failure. For example, an asset stripper could buy a failing firm – selling
off its assets and then make workers redundant. Alternatively, a firm may increase
profits by finding ways around environmental regulation and cause more pollution.
Also, a firm may seek short-run profit maximization and under-invest in the long-term.

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Behavioral economists argue that economics can often over-emphasis the role of profit.
For example, individuals are motivated by many factors other than profit, such as pride
in work, desire to work in bigger company, be successful and attachment to ideas –
even if unprofitable.

CONCLUSION

Higher profit enables firms to invest in more research and development, leading to
better products in the long-term. Higher profit also acts as a signal to other
entrepreneurs to increase investment in that industry. However, others are concerned
higher profitability reflect monopoly power and an unfair transfer of income from
consumers to shareholders.

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 BIBLIOGRAPHY

The content has been taken from:-

WEB

 Slide share.com
 Wikipedia

ARTICLE

 Article by Tejvan pettinger

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