□ Profit Theory
The undisturbed funds are as the source of the internal funds of financing investment.
The investment depends upon the profit and the profits depend on the income.
When the capital market is imperfect the Retained Earnings are of great importance to use them by small and large firms.
We know that the Retained Earnings is directly proportional to profits and the cost of capital is low and optimal caoital stock is large.
The comapny invests profits instead of providing it to the shareholders. This is the liquidity theory of profit.
The another version of the optimal capital stock is a function of the expected profits. If the aggregate profits in the economy and the business profits are rising.
They may lead to expectations of their continues to increase in the future. Thus expected profits are same function of actual profits in the past.
Say, K * = F (pi t - 1)
where, K * = Optimum capital Stock
F (pi t - 1) = some function of past actual profits.
Thus this is how profit theory of investment is defined.
Thank You
Aditya Pokhrel
MBA, MA Economics, MPA
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