The importance of profit motive in a market economy is that all firms are established on its basis. The fundamental economic questions of what to produce, how to produce and for whom to produce are answered by profit motive and price mechanism:
What to produce: in market economies, that which is most profitable is produced
How to produce: that technology, whether capital, or labour intensive, which is most profitable is used
For whom to produce: the goods are produced and sold to people, through whom maximum profit can be derived
Price Mechanism, which is the “invisible hand in guiding an economy” is also governed by profit motive. Goods will be sold at that price at which:
- more goods will be purchased and consumed
- more profits will be made
Thus goods will be sold at the most profitable price
Profit motive also has its own advantages:
- it creates incentives for newer products to be made
- it provides incentives for employees to work efficiently
- it ensures efficient utilization of resources
- competition is created, thus only good quality goods survive
- there is development of technology to allow quicker and cheaper production of goods
There are also, however, some disadvantages of overemphasis on profit motive.
-
Misallocation of resources: due to profit motive, firms concentrate on producing that what is most profitable, and not what is most needed. Therefore, precious resources get used in the production of luxury goods, while even basic necessities are not fulfilled. E.g. money is spent on making perfumes, while food and clothing is not available to many
-
Neglect of moral values: the profit motive becomes so strong that firms go through any means to achieve their profits and make money.
-
Exploitation of workers: this is mostly in developing countries, where wages are put very low. To make profit, employers try to extract maximum work with minimum payment
-
Ruthless exploitation of resources: in order to make more profitable goods, resources are used quickly, without much planning for the future, resulting in degradation of ecology, pollution, and future scarcity of resources
-
Wastage: since newer machines and technologies are brought out, old ones are discarded. Also, when new goods are introduced in the market, the old ones are thrown away. Therefore there is wastage of resources
-
Economic imbalances: although not a direct influence of profit motive, cyclic booms and recessions are caused due to over dependence on price mechanism, causing periodic unemployment.
Thus it is clear that profit motive has its pros and cons. In order to avoid the cons, economies impose government restrictions so that profit is made, but welfare of the people is also maintained. This is also one of the reasons why mixed economies were established. Now there is no pure market economy.