4.7

• profit definition

  The difference between total sales revenue and total cost of production
• what is profit maximisation?

  occurs at the level of output at which total profit is greatest
• normal profit definition

  the minimum profit a firm must make to stay in business, which is, however, insufficient to attract new firms into the market
• when does normal profit occur?

  when total revenue = total cost, including opportunity costs - its the minimum reward needed to keep resources in their current use
• abnormal (supernormal) profit definiton

  profit over and above normal profit
• when does abnormal profit occur?

  when total revenue is greater than total cost, including opportunity costs
• normal profit varies from one industry to another, depending on the risks facing firms
• what is accounting profit?

  • accounting profit = total revenue - explicit costs
  • doesn’t include opportunity costs (unlike economic profit)
• what is economic profit?

  • economic profit = accounting profit - opportunity cost
  • its what economists use to assess whether a firm is truly profitable
• when is profit maximised ?

  • where marginal cost = marginal revenue
  • this is because any extra unit beyond that point would cost more than it earns
• whats the different between short-run and long-run profits?

  • in the short run, firms can make supernormal profits
  • in the long run, in competing markets, normal profit is the most common due to entry and exit
• how does competition affect profits in the long run ?

  In perfect competion, new firms enter the marekt when profits are high, increasing supply and lowering price until normal profit remains
• how do monopolies maintain supernormal profits in the long run?

  they use barriers to entry like:

  • legal protection (e.g patents)
  • economies of scale
  • brand loyalty

  this limits competition and protect profit
• What is the role of profit in the market economy ?

  Profits act as a signal, reward and incentive:

  • directs resources
  • Rewards risk and innovation
  • Funds investment
  • Motivates workers and shareholders
• how does profit create worker incentives?

  firms use profits to pay:

  • wages and bonuses
  • commission schemes

  high profits may also mean better job security and promotion opportunities
• how does profit create shareholder incentives?

  • shareholders receive dividends (a share of profits)
  • higher profits = bigger returns = more investment
  • profit also boosts share prices, increasing shareholder wealth
• how do profits influence resource allocation?

  • high profits in a sector signal high consumer demand, attracting new firms
  • resources are reallocated to where profit s greatest = efficient use of resources
• how are profits a reward for innovation and risk-taking?

  entrepreneurs who create new products or improve processes earn supernormal profit as a reward for:

  • taking risks
  • Creating something better or cheaper
  • Meeting unmet demand
• how are profits a source of business finance?

  firms reinvest retained profits to:

  • expand production
  • develop new products
  • train staff
  • upgrade technology

  it avoids taking on debt an fuels long-term growth
• why is profit important in a capitalist economy ?

  in capitalism:

  • firms are privately owned
  • profit is the main objective
  • it ensure efficient production, consumer choice and innovation

  without profit, firms would lack motivation to produce what people want
• what could happen if profits fall or disappear?

  • reduced investment
  • job losses
  • falling incentives for innovation
  • firms may exit the markets, reducing competition