Profit

Accounting Profit - Total Revenue - Total Costs
Super-normal Profit (SNP) - The amount of profit above normal profit

Normal Profit

Normal profit is the minimum amount of profit required to remain in a marketplace.

If the profit falls below this, then the firm will leave the marketplace and switch to the next best alternative market (provided there are low barriers to exit / low sunk costs).

The Role of Profit

Profit plays an important role in the market economy.

  • Profit is the reward to shareholders and owners of a business
  • Profit creates incentives for enterprise / innovation
  • Profit attracts more firms to an industry, increasing competition
    • This decreases prices in the LR, as firms compete on price
    • This leads to increased choice as there are more products from different firms to chose from
    • Super-normal profit is competed away in the LR
  • Profit in the LR allows for Research & Development
    • This leads to dynamic efficiency
    • This leads to lower prices and higher quality products in the LR
    • Increased productivity -> economic growth
  • Lack of profit in a industry will cause firms to leave the industry
    • This means profit helps signal where more or less supply is needed in an industry, helping to achieve allocative efficiency
  • Higher profit enables wages to rise
  • Profit can be taxed via corporate tax to allow the government to gain revenue
  • Profit can allow firms to build up a buffer against an economic downturn

Profit Evaluation

  • Profit can drive firms to cut corners, for example:
    • Dumping waste / excess pollution
    • Underpaying workers
  • Profit can cause firms to take too many risks, i.e 2008
  • Profit can lead to inequality especially if firms have monopoly/monopsony power
    • It can allow market abuse, such as undercutting competitors to drive out competition
  • Firms may have other objectives