profit

Normal Profit, Supernormal Profit & Losses

• When calculating costs, Economists consider both the explicit and implicit costs of production

  • Explicit costs are the costs which have to be paid e.g raw materials, wages etc.

  • Implicit costs are the opportunity costs of production

    • This is the cost of the next best alternative to employing the firm’s resources

    • E.g. if an investor puts £1m into producing bicycles & they could have put it in the bank to receive 5% interest, then the 5% represents an implicit cost

  • Implicit costs must be considered, as entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere

• Profit = total revenue (TR) – total costs (TC)

  • Total costs include explicit and implicit costs

• Normal profit occurs when TR = TC 

  • This is also called breakeven

• Abnormal (supernormal) profit occurs when TR > TC

• A loss occurs when TR < TC

Profit Calculations

Observations

• Supernormal profit occurs up to the 6th unit of output

• Normal profits occur at the 7th unit

• From the 8th unit, the firm is making a loss

The role of Profit in a Market Economy

• Profit plays a central role in a market economy

1. Profit is an incentive for innovation and entrepreneurship

• Profit serves as a reward for successful entrepreneurship and innovation

• Entrepreneurs take on risks to start businesses or develop new products/services with the expectation of making a profit

• It encourages individuals to innovate, leading to economic growth and improved standards of living

2. Allocation of resources

• In a market economy, profit serves as a signal for resource allocation

• When businesses earn profits, it indicates that they are meeting consumer demands efficiently

• This encourages the reallocation of resources (capital, labour, and land) towards the production of goods and services that consumers value most, thereby enhancing economic efficiency

3. Competition

• Profit serves as a measure of business success and efficiency

• In a competitive market, firms strive to maximise profit by improving productivity, lowering costs or enhancing the quality of goods and services

• This competition benefits consumers by providing them with better products at lower prices

4. Economic growth

• Profitable businesses reinvest their earnings into expanding operations, research and development, and hiring more workers

• This investment stimulates economic growth, creates jobs, and generates technological advancements

5.Wealth creation

• Profit generation leads to wealth creation for businesses, shareholders, and employees

• It enables businesses to accumulate capital, which can be reinvested or distributed to shareholders as dividends

• Employees also often benefit from profit-sharing schemes or performance-based bonuses

• It is essential to recognise that excessive focus on profit maximisation without considering social and environmental factors can lead to negative externalities, such as environmental degradation, income inequality, or exploitation of labour

• While profit is a crucial driver of economic activity, it should be pursued within the framework of ethical and sustainable business practices