A profit system is a feature of the free market economy in which profit dictates how activities and opportunities are chosen by entrepreneurs and businesses. The “invisible hand” theory is a classic example of a profit system. This theory was first documented by Adam Smith, an 18th century Scottish philosopher and economics pioneer who is known as the father of the free market enterprise theory. The invisible hand theory states that economic resources are allocated and used in a free market enterprise based on the self interest, competition, and supply and demand of the individuals in the economy.
The economic resource movement seen in the invisible hand theory is often linked to the ability of individuals and businesses to generate profit from these resources. In order to maximize profit, companies must use economic resources effectively and find ways to sell goods or services to consumers in the economic marketplace. A profit system may also be linked to the economic theories of the business cycle or supply and demand.
The business cycle is an economy wide fluctuation that usually occurs over several months or years. The business cycle is seeking to trends of expansion, plateau and contraction; this cycle usually repeats itself in the entire economy, individual business industry, or business sector. In most business cycles, the highest value profit system usually occurs in the expansion stage. This stage commonly has the most growth potential, since consumer demand is on the rise. An economy-wide expansion often indicates that consumer income levels have increased to a point where more consumption purchases will be made. Many companies are started during the business cycle expansion to take advantage of this situation.
During the plateau stage of the business cycle, the profit system potential has usually peaked and sales have leveled off. Companies have probably maximized the profit potential in the economy, industry, or business sector, and may be looking to leave due to declining demand. A plateau stage may also occur when a nation’s economy has seen its gross domestic product percentage level off for several quarters in a row. Plateau stages often lead to the contraction stage of the business cycle.
A company’s profits system will usually decline significantly during a business cycle contraction. Consumer demand has usually tapered off for specific goods or services, and consumers may have ceased to purchase these products altogether. Companies will start to lose money on these business functions and will look for new business cycle expansions where a new profits system may be occurring. Once a new expansion stage is found by companies, the entire profit system process will usually repeat itself in the economic environment.