How does the profit motive helps lead to efficient use of productive resources?

In economics, the profit motive is the motivation of firms that operate so as to maximize their profits. Mainstream microeconomic theory posits that the ultimate goal of a business is "to make money" - not in the sense of increasing the firm's stock of means of payment (which is usually kept to a necessary minimum because means of payment incur costs, i.e. interest or foregone yields), but in the sense of "increasing net worth". Stated differently, the reason for a business's existence is to turn a profit. The profit motive is a key tenet of rational choice theory, or the theory that economic agents tend to pursue what is in their own best interests. In accordance with this doctrine, businesses seek to benefit themselves and/or their shareholders by maximizing profits.

As it extends beyond economics into ideology, the profit motive has been a major matter of contention.

Economics[edit]

Theoretically, when an economy is fully competitive (i.e. has no market imperfections like externalities, monopolies, information or power imbalances etc), the profit motive ensures that resources are being allocated efficiently. For instance, Austrian economist Henry Hazlitt explains, “If there is no profit in making an article, it is a sign that the labor and capital devoted to its production are misdirected: the value of the resources that must be used up in making the article is greater than the value of the article itself." In other words, profits let companies know whether an item is worth producing. Theoretically in free and competitive markets, if an individual firm maximizes profits, it ensures that resources are not wasted. However, the market itself, should minimize profits as it is the cost to the value chain. Competition is the key tool by which markets overcome the individual firm's profit maximization incentive. The profit motive is a good of value to the economy. It is needed to provide incentive to generate efficiency and innovation. However, over-remuneration of the profit motive creates profit inefficiency. With massive reductions in competition in many industries due to consolidation and mergers, the US economy has become profit inefficient, with record profits occurring in recent years. This creates a deadweight loss to the economy.

Criticisms[edit]

The majority of criticisms against the profit motive center on the idea that profits should not supersede the needs of people or the environment. Michael Moore’s film Sicko, for example, attacks the healthcare industry for its alleged emphasis on profits at the expense of patients. Moore explains:

Another common criticism of the profit motive is that it is believed to encourage selfishness and greed. Critics of the profit motive contend that companies disregard morals or public safety in the pursuit of profits.

Counter-criticisms[edit]

Free-market economists argue that the profit motive, coupled with competition, often reduces the final price of an item for consumption, rather than raising it. They argue that businesses profit by selling a good at a lower price and at a greater volume than the competition. Economist Thomas Sowell uses supermarkets as an example to illustrate this point: "It has been estimated that a supermarket makes a clear profit of about a penny on a dollar of sales. If that sounds pretty skimpy, remember that it is collecting that penny on every dollar at several cash registers simultaneously and, in many cases, around the clock."

Economist Milton Friedman has argued that greed and self-interest are universal human traits. On a 1979 episode of The Phil Donahue Show, Friedman states, "The world runs on individuals pursuing their separate interests." He continues by arguing that only in capitalist countries, where individuals can pursue their own self-interest, people have been able to escape from "grinding poverty".

Author and philosopher Ayn Rand defended selfishness on ethical grounds. Her nonfiction work, The Virtue of Selfishness, argues that selfishness is a moral good and not an excuse to act with disregard for others:

Profit motive refers to an entity’s intention that drives the entity to indulge in profit-making activities to achieve financial gain and profit. This powerful force motivates the entity to attain and accumulate wealth until the need or desire is satisfied.

In economics, the profit motive drives business owners to enter into business deals and take the risk. There is no right reason to run a business without achieving economic benefit, no matter its scale or size. Primarily this factor makes them different from non-profit organizations.

Table of contents

Key Takeaways

• Profit motive meaning portrays an entity’s intention to indulge in profit-making activities to achieve financial gain and profit.
• It interprets how an entity is prepared to take risks, innovate, coordinate and work hard that they won’t perform otherwise if there wasn’t a personal or economic gain.
• It is an essential element in capitalism and drives people to decide and perform based on self-interest. 
• It explains the existence of businesses and their contributions to the economy.

Profit Motive Explained

The profit motive is an important feature of capitalismCapitalismCapitalism is an economic system consisting of businesses, resources, capital goods, and labour. Private entities own it, and the income is derived by the level of production of these factors. Because of the private hands, these entities can be operated efficiently and maximize their production activity also.read more. Acting in self-interest to make personal gain is a vital element in a capitalist economyCapitalist EconomyA capitalist economy or a free market economy is characterized by private ownership, private production, and profit orientation wherein the role of government is limited to regulating and monitoring. Finally, an alternate economic system is the socialist/command economy that operates on a welfare motive. All production, investments, and price determination decisions rest with the government.read more. Self-interest and consistently aiming for profit result in the expansion of economic wealth. Hence, it aligns with Adam Smith’s invisible hand theory and contributes to the unseen force that moves the free market economyFree Market EconomyA free market refers to an economic system free from government interventions and controlled by privately owned businesses.read more.

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Every entity in the world can have profit-seeking characteristics. For example, the government can manage policies, and companies adjust strategies for profit maximization. Sometimes, consumers reflect profit-making behavior while purchasing even though profit maximization is inadequate for consumer behavior explanation.

Its positive influence can be observed from the impact created by entities like for-profit schools and health care institutions. The profit-seeking feature and competition enhance the performance, affordability, and quality exhibited by the schools and health care institutions, benefiting society. However, at the same time, for-profit organizations radiate negative influence also. For example, private schools or hospitals may fail to fulfill their obligations towards the poor people and affecting trust-based relationships in society.

Examples

Jacob is an employee in a good company. He did his job perfectly for years and enjoyed benefits like salary hikes, promotions, and other job perks that came along with his title. But soon realized that it wasn’t enough and should start his own business to earn more. Jacob always wanted to be a chef. So after giving it much thought, he resigned from his job and started his small restaurant; soon, through good taste, efficient customer service, and word of mouth publicity, his restaurant acquired a good reputation. Gradually he started earning well and more than what he was making as an employee.

In this profit motive example, the sole intent behind starting the restaurant was a profit, and he was driven by it; there were possibilities that he would have incurred heavy loss or have had a bad experience operating his own business for the first time, but he was willing to take the risk to earn more which he would’ve not accepted if it wasn’t for a monetary gain in the first place.

To understand the concept, let’s look into an example from daily life. A person named Robin daily hitchhikes to his office in his neighbor’s car since the neighbor also travels in the same direction. Every day Robin deliberately comes out in the morning at the same time his neighbor does, and the neighbor will offer a ride. If his neighbor leaves late, it will make Robin late, but again he is willing to take that risk and continue doing it because it helps him save transportation costs and add to his earnings.

Why is it Important?

• The profit motive is deeply connected to business economicsBusiness EconomicsBusiness Economics defines the economic issues faced by an entity. It determine how much is the impact of a certain change in an economic factor on the profitability or revenues of a given business and uses this analysis in steering the firm’s decision-making.read more, and thus, an intent to generate profit is a positive side of doing business. Entities cannot sustain in business without making a profit.
• Indulging in business activityBusiness ActivityBusiness activities refer to the activities performed by businesses to make a profit and ensure business continuity. read more for a profit motive ultimately helps other stakeholders. For example, taxes collected from profitable businesses contribute to government revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more, and profitable businesses create jobs.
• It is the foundation of economic and entrepreneurial activities. Therefore, earning more and more contributes to the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more.
• Industrialization, technological advancement, and elimination of trade barriers are indirectly connected to it.
• Individuals with a profit-reaping mindset become creative; they invent and innovate. It encourages employees, individuals, and organizations to indulge in innovative ways of doing a task.
• Understanding the concept is important and helps academics analyze and interpret various business activities.
• Profit is directly proportional to risk; the more risk involved, the more the profit potential. This idea has encouraged many businesses to think out of the box.

Frequently Asked Questions (FAQs)

What is the profit motive definition of economics?

It refers to a reason to make a profit possessed by an individual or firm engaged in a transaction or business. It explains that the primary objective of any business is to earn profit. Therefore, all the manufacturing goods, products, and services rendered are provided to make a profit.

Why is profit motive important?

It is important because when a business or transaction earns profit, it helps elevate the lifestyle of the people associated with it and contributes to the betterment of society and the people living in it.

What is an example of the profit motive in economics?

The owner of a grocery store opened it intending to make a profit by selling groceries. The output of all the activities and processes performed should directly or indirectly contribute to the revenue from the store. If the store fails to make a profit even after a sufficient period, it will affect the going concern concept of the store.

Recommended Articles

This has been a Guide to what is profit motive & its definition in Economics. We explain profit motive meaning, examples, and its importance. You can learn more from the following articles –

• Capitalist EconomyCapitalist EconomyA capitalist economy or a free market economy is characterized by private ownership, private production, and profit orientation wherein the role of government is limited to regulating and monitoring. Finally, an alternate economic system is the socialist/command economy that operates on a welfare motive. All production, investments, and price determination decisions rest with the government.read more
• Wage-Price SpiralWage-Price SpiralThe wage-price spiral theory in macroeconomics describes the vicious circle of rising wages and increasing prices.read more
• Public-Private PartnershipPublic-Private PartnershipPubic-private partnership refers to a collaborative model whereby the government agency collaborates with a private sector organization to accomplish a large-scale infrastructure project through private funding. Such projects include the construction of dams, bridges, airports, roads, etc.

  How does profit motive help lead to use of productive resources?

  How does a profit motive help lead to efficient use of productive resources? The more it costs a producer to make something the lower the profit. The profit motive will guide producers to efficient allocation of resources in order to earn as large a profit as possible.

  How important does the profit motives in the economic system?

  It can encourage innovation and improvements to society through gain. Profit can motivate innovations in technology and medicine, supplying individuals with a reason to invest time and money into creating something new and useful for others. Motivation through profit can add value to other products in the economy.

  What is the purpose of the profit motive?

  Having a profit motive means that you intend to earn more in revenue from the activity than you incur in expenses. It doesn't mean you'll necessarily earn a profit. It just means that that's your intent.

  Which of the following best explains why the profit motive leads to efficiency and innovation?

  Which best explains why the profit motive often leads to efficiency and innovation? Profit gives producers more money to be able to buy better resources.