Readers Question: Anyone is free to buy stock in FirmA, so everyone is free to share in FirmA’s economic profit and the bigger that economic profit, the better for all. Critically evaluate this statement.
Some points to consider:
Benefits of Profit
- Higher dividends for shareholders
- Profit can be used to invest in research and development, leading to better quality products for consumers in the long run
- Profit can be used to create savings for a cyclical downtun and avoid firms going bankrupt
Evaluation
- The statement suggests everyone is free to buy shares. But, in reality very few have the ability to buy shares. Due to transaction costs, it requires a large amount
- Buying shares can be risky. Firms can go bankrupt leaving shareholders with nothing (e.g. Woolworths). Therefore a small investor is better off saving in less risky investments than shares.
- Growth in share dividends tend to benefit the wealthy section of the population.
- Monopolies can create bigger profits by charging high prices. However, this is allocatively inefficient (price greater than marginal cost) leading to deadweight welfare loss. Furthermore, those who lose out will be those on low incomes
- Firms who maximise profits for shareholders may ignore long term objectives such as investing in better infrastructure. Or they may seek to maximise profit by cutting corners – e.g. not following environmental legislation.
See also: Role of profit in economy
2 comments ↓
This is a very interesting analysis of profit and the article was informative.
Great article. I agree.
Bigger profits does not necessarily mean a bigger benefits for all (i.e. society). What matters is productivity and return on investment. If, due to the size of its profits and demand for investment, Firm A is crowding out investment in other more productive assets then society is actually at a disadvantage due to Firm A’s size.
Third,
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