3.3.4 profit

• profit

  profit = revenue - costs
• costs according to accountants

  costs of factors of production
• costs according to economists

  costs of factors of production + opportunity cost
• normal profit

  minimum level of profit required to continue to produce a given good or service

  AR=AC
• supernormal profit

  profit in excess of normal profit

  AR>AC

  incentive for other producers to enter the market when other firms are making supernormal profit
• subnormal profit

  economic loss

  AR<AC

  if looked at accounts we may see an 'accounting profit' as they don't include opportunity cost
• profits for a price maker

  MC=MR, profit maximisation point

  position of average cost curve will determine the level of output

  
• normal profit for price maker

  AR=AC is normal profit

  
• supernormal profit for a price maker

  AR>AC

  
• subnormal profit for a price marker

  AC>AR

  
• normal profits for price taker

  AC = AR

  
• supernormal profit for price taker

  AR>AC

  
• subnormal profit for price taker

  AC>AR

  
• importance of profit

  an important objective for most but not all firms

  provides finance for capital investment and research: retained profits are a key source of finance for businesses undertaking investments as well as being funds for acquisitions

  rising supernormal profits signal to other producers to enter the market

  can send signals about the health of the economy, high profits might signal improvements in supply side performance, they are also the result of higher levels of AD e.g. during an economic recession
• strategies a firm may have to increase profits

  reduce overhead costs (fixed costs) so average costs fall

  increase labour productivity or outsource some production to lower costs

  develop new products with lower PED and high YED

  discount prices if the business estimates that demand is highly price elastic

  find new customers in new markets e.g. export to more countries
• economic benefits of a firm making a profit

  provides money to spend on research and development and improving factors of production

  allows governments to receive higher revenue from corporation tax

  signals the success of the firm in meeting consumer wants/needs and acts as an incentive for future growth

  can be saved to act as a buffer should firms face a sudden downturn in demand
• economic costs of a firm making a profit

  profits may be spent on shareholder dividends as opposed to improving the quantity and quality of factors of production

  increase economic inequality if costs (wages of workers) are driven down whilst incomes of owners/shareholders increase

  may attract new entrants in to the market which may lower future profits (but benefits consumers)

  comes at the cost of other objectives
• shut down points

  the minimum price a firm requires to continue to produce a product

  in the LR a firm must make normal profit to justify staying in the market - must have price and output at least where P=AC

  if price (AR) is less than AC in the LR the firm will shut down in theory, but firms can survive while making a loss as managers are satisficing or where a downturn is seen as temporary and demand is expected to pick up again - losses may be subsidised by profits from other sectors/markets
• shut down points

  in the SR a firm will supply their products as long as price per unit is greater than or equal to average variable cost (i.e. where AR=AVC)

  provided price (AR) > AVC, there will be a contribution being made to the fixed costs

  if price (AR) < AVC, the firm will likely shut down and this is the short-run shut-down price in a competitive market