A not-for-profit organization is an organization whose purpose is to pursue a mission (social, educational, cultural, religious, scientific, etc.) and that typically faces a non-distribution constraint: any surplus is reinvested in the mission rather than paid out to owners as profit. In many contexts the term is used interchangeably with non-profit organization, though legal definitions can differ by jurisdiction.
What Makes It Different From A For-Profit Firm
The key economic distinction is not “it never earns a surplus.” It can. The distinction is what happens to the surplus:
- A for-profit can distribute profits to owners/shareholders.
- A not-for-profit generally must keep surplus within the organization (service expansion, reserves, staff, facilities).
That constraint affects incentives, governance, and trust.
Why Do Not-For-Profits Exist? (Economic Logic)
Economists usually explain not-for-profits as responses to frictions and failures:
Public goods and externalities
Some outputs generate benefits that are hard to charge for (public goods) or spill over to others (positive externalities). Not-for-profits can mobilize donations and volunteer time to produce socially valuable services that the market undersupplies.
Contract failure (hard-to-observe quality)
In services like childcare, elder care, education, or health, quality can be hard to monitor. The non-distribution constraint can make providers more trustworthy because there is less incentive to cut hidden quality to raise profits.
Government failure and pluralism
Even when government provides services, it may not match diverse preferences. Not-for-profits can target specific communities and tailor services.
Agency problems and governance
Not-for-profits still face principal-agent issues (managers vs donors/beneficiaries). Board oversight, reporting, and donor discipline are mechanisms to reduce waste and mission drift.
How They Finance Themselves
Common revenue sources include:
- donations and grants,
- membership dues,
- user fees (tuition, ticket sales, service charges),
- investment income from endowments.
Each source changes incentives. For example, heavy reliance on grants can create compliance burden and goal distortion; heavy reliance on fees can make a not-for-profit behave more like a market provider.
Policy Context: Taxes And Subsidies
Many jurisdictions give not-for-profits some mix of:
- tax exemption on surplus,
- donation incentives (credits/deductions),
- eligibility for government grants and subsidized programs.
These policies effectively lower the “price” of giving and can increase donations, but they can also shift resources toward activities that fit eligibility rules rather than social value.
Related Terms
- Non-Profit Organization
- Non-Governmental Organization
- Public Good
- Externality
- Social Welfare
- Public Finance
- Tax Credit
- Subsidy
- Agency Problem
- Public Choice