Economics - Profit and Revenue
Economics - Profit and Revenue
Economics - Profit and Revenue
This occurs when TR = TC. This is the break-even point for a firm (P2). It is
the minimum profit level to keep the firm in the industry in the long run.
See more on normal profit.
Normal profit
Normal profit is a situation where a firm makes sufficient
revenue to cover its total costs and remain competitive in an
industry.
In measuring normal profit, we include the opportunity cost of
working elsewhere.
When a firm makes normal profit we say the economic profit
is zero.
Normal profit = total revenue – total costs
Where total costs =
Explicit costs (rent, labour costs, raw materials +)
Implicit costs (opportunity cost of capital/working
elsewhere)
Diagram showing normal profit
Normal profit occurs at an output where average revenue (AR) = average
total costs (ATC)
Normal profit implies zero economic profit. However, this can include
‘accounting profit’. This is because included in the total costs is a minimum
level of recompense for the owners of the company. For example, if a
typical salary was £20,000 working elsewhere, this salary of £20,000 would
be included in total costs.
This is why normal profits will be made in the long run. At Q1 – AR=ATC.
Economic profit is any profit above the level of normal profit. It is also
referred to as supernormal profit.
In a monopoly, firms are able to make greater than normal profits. There
are barriers to entry and they can charge a price higher than average
Supernormal Profits
10 September 2019 by Tejvan Pettinger
Supernormal profit is all the excess profit a firm makes above
the minimum return necessary to keep a firm in business.
Supernormal profit is calculated by Total Revenue – Total
Costs (where total cost includes all fixed and variable costs,
plus minimum income necessary for the owner to be happy in
that business.)
Normal profit is defined as the minimum level of profit
necessary to keep a firm in that line of business. This level of
normal profit enables the firm to pay a reasonable salary to its
workers and managers. The definition of normal profit occurs
when AR=ATC (average revenue = average total cost)
Supernormal profit is defined as extra profit above that level
of normal profit.
Supernormal profit is also known as abnormal profit.
Abnormal profit means there is an incentive for other firms to
enter the industry. (if they can)
When the price is P3, the firm makes supernormal profit. This is because
at P3, Average revenue is greater than average total cost. (ATC)
Perfect information
Freedom of Entry and exit
Suppose there is a rise in demand, price rises and a firm can make
supernormal profit in the short-term.
The supernormal profit is (AR – AC) * Q2. Other firms will be aware of this
fact. Because there are no barriers to entry, firms will be encouraged to
enter the market until price falls back down to P1 and normal profits are
made.
Allocative Efficiency
Definition of allocative efficiency
This occurs when there is an optimal distribution of goods and services,
taking into account consumer’s preferences.
Allocative efficiency will occur at a price of £11. This is where the marginal
cost (MC) = marginal utility.
Dynamic Efficiency
28 August 2019 by Tejvan Pettinger
Definition of Dynamic Efficiency
Dynamic efficiency is concerned with the productive efficiency of a firm
over a period of time.
At the start of the internet, Yahoo was the dominant search engine, but it
quickly lost its position to a new entrant – Google. In an industry like the
internet, a firm cannot stand still but has to be continually innovating and
improving the quality of its product and lowering costs.
Related concepts
Economic Efficiency
28 June 2019 by Tejvan Pettinger
Definition of efficiency
This occurs when the maximum number of goods and services are
produced with a given amount of inputs. This will occur on the production
possibility frontier. On the curve, it is impossible to produce more goods
without producing fewer services. Productive efficiency will also occur at
the lowest point on the firm’s average costs curve. (Q1)
See: Productive Efficiency
2. Allocative efficiency
See: Allocative Efficiency
3. X inefficiency
This occurs when firms do not have incentives to cut costs, for example, a
monopoly which makes supernormal profits may have little incentive to
get rid of surplus labour.
If a firm’s average costs are higher than potential – then we are x-
inefficient.
See: X Inefficiency
4. Efficiency of scale
This occurs when the firms produce on the lowest point of its long-run
average cost (Q2) and therefore benefits fully from economies of scale
5. Dynamic efficiency
This refers to efficiency over time, for example, a Ford factory in 2010 may
be very efficient for the time period, but by 2017, it could have lost this
relative advantage and by comparison, would now be inefficient. Dynamic
efficiency involves the introduction of new technology and working
practices to reduce costs over time.
Dynamic efficiency
Static efficiency – efficiency at a particular point in time.
6. Social efficiency
This occurs when externalities are taken into consideration and occurs at
an output where the social cost of production (SMC) = the social benefit
(SMB)
Social efficiency occurs at an output of 16 – where SMB = SMC
See: Social efficiency
7. Technical efficiency
This requires the optimum combination of factor inputs to produce a
good: it is related to productive efficiency.
See: Technical efficiency
8. Pareto efficiency
A situation where resources are distributed in the most efficient way. It is
defined as a situation where it is not possible to make one party better off
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