Profit (economics)
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In economics, profit is the difference between revenue that an economic entity has received from its outputs and total costs of its inputs, also known as surplus value.[1] It is equal to total revenue minus total cost, including both explicit and implicit costs.[2]
It is different from
Normal profit is often viewed in conjunction with economic profit. Normal profits in business refer to a situation where a company generates revenue that is equal to the total costs incurred in its operation, thus allowing it to remain operational in a competitive industry. It is the minimum profit level that a company can achieve to justify its continued operation in the market where there is competition. In order to determine if a company has achieved normal profit, they first have to calculate their economic profit. If the company's total revenue is equal to its total costs, then its economic profit is equal to zero and the company is in a state of normal profit. Normal profit occurs when resources are being used in the most efficient way at the highest and best use. Normal profit and economic profit are economic considerations while
Normal profit = Total revenue – Total costs |
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Normal profit = Revenues – Total costs |
Normal profit = Revenues – (Implicit costs + Explicit costs) |
Economic profits arise in
Competitive and contestable markets
Companies do not make any economic profits in a
The same is likewise true of the
Economic profit can, however, occur in competitive and contestable markets in the short run, since short run economic profits attract new competitors and prices fall. Economic loss forces firms out of the industry and prices rise till marginal revenue equals marginal cost, then reach long run equilibrium. As a result of firms jostling for market position. Once risk is accounted for, long-lasting economic profit in a competitive market is thus viewed as the result of constant cost-cutting and performance improvement ahead of industry competitors, allowing costs to be below the market-set price.
Uncompetitive markets
The existence of economic profits depends on the prevalence of
An oligopoly is a case where barriers are present, but more than one firm is able to maintain the majority of the market share. In an oligopoly, firms are able to collude and limit production, thereby restricting supply and maintaining a constant economic profit.[7][10][2] An extreme case of an uncompetitive market is a monopoly, where only one firm has the ability to supply a good which has no close substitutes.[14] In this case, the monopolist can set its price at any level it desires, maintaining a substantial economic profit. In both scenarios, firms are able to maintain an economic profit by setting prices well above the costs of production, receiving an income that is significantly more than its implicit and explicit costs.
Government intervention
The existence of uncompetitive markets puts consumers at risk of paying substantially higher prices for lower quality products.[15] When monopolies and oligopolies hold large portions of the market share, less emphasis is placed on consumer demand than there would be in a perfectly competitive market, especially if the good provided has an inelastic demand. Government intervention basically creates uncompetitive markets by restrictions and subsidies.[16] Governments also intervene in uncompetitive markets in an attempt to raise the number of firms in the industry, but these firms cannot support the needs of consumers as if they were born out of a profit generated on a competitive market basis.[17]
On the other hand, if a government feels it is impractical to have a competitive market—such as in the case of a natural monopoly—it will allow a monopolistic market to occur. The government will regulate the existing uncompetitive market and control the price the firms charge for their product.[8][9] For example, the old AT&T (regulated) monopoly, which existed before the courts ordered its breakup, had to get government approval to raise its prices. The government examined the monopoly's costs, and determined whether or not the monopoly should be able raise its price. If the government felt that the cost did not justify a higher price, it rejected the monopoly's application for a higher price. Though a regulated firm will not have an economic profit as large as it would in an unregulated situation, it can still make profits well above a competitive firm in a truly competitive market.[9]
Maximization
It is a standard economic assumption (although not necessarily a perfect one in the real world) that, other things being equal, a firm will attempt to maximize its profits.
Another significant factor for profit maximization is market fractionation. A company may sell goods in several regions or in several countries. Profit is maximized by treating each location as a separate market.[21] Rather than matching supply and demand for the entire company the matching is done within each market. Each market has different competitions, different supply constraints (like shipping) and different social factors. When the price of goods in each market area is set by each market then overall profit is maximized.
Other applications of the term
The social profit from a firm's activities is the accounting profit plus or minus any
For the
See also
- Economic surplus
- Economic rent
- Economic value added
- Externality
- Inverse demand function
- Profit motive
- Profitability index
- Rate of profit
- Superprofit
- Surplus value
- Tendency of the rate of profit to fall
- Value (economics)
Notes
- ^
Arnold, Roger A. (2001). Economics (5 ed.). South-Western College Publishing. p. 475. ISBN 9780324071450. Retrieved 14 April 2021.
Economic profit is the difference between total revenue and total opportunity cost, including both its explicit and implicit components. [...] Economic profit = Total revenue – Total opportunity cost [...]
- ^ a b c d e Black, 2003.
- ^ Mankiw, Gregory (2013). Principles of Economics. CENGAGE Lesrning.
- ^
Hubbard, Glenn; O'Brien, Anthony (2014). Essentials of Economics, Global Edition (4 ed.). Pearson Education Limited. p. 397. ISBN 9781292079172.
- ^ Lipsey, 1975. pp. 285–59.
- ^ Lipsey, 1975. p. 217.
- ^ a b c d e f g h i j Chiller, 1991.
- ^ a b c d e f g h Mansfield, 1979.
- ^ a b c d e f g LeRoy Miller, 1982.
- ^ a b c d e f g Tirole, 1988.
- ^ Saloner, Garth (2001). Strategic Management. John Wiley. p. 216.
- ISBN 978-1-349-95121-5.
- ^ Mankiw, Gregory (2016). principles of economics. Cengage learning. p. 288.
- ^ ISBN 9781292215624.
- ISBN 9781292081977.
- CiteSeerX 10.1.1.412.1477.
- ^ Rowe, James L. (2017). "Back to Basics: Economic concepts explained" (PDF). International Monetary Fund.
- ^ "United States of America, Plaintiff, v. Microsoft Corporation, Defendant", Final Judgement, Civil Action No. 98-1232, 12 November 2002.
- ^ Hirshleifer et al., 2005. p. 160.
- ^ Pettinger, Tejvan (16 July 2019). "Profit Maximisation". Economics help.
- ^ Regional Outlook (20 May 2021). "Industry Analysis Report and Forecast, 2021 - 2027". GLOBE NEWSWIRE.
- ^ "'Profit' variability in for-profit and not-for-profit hospitals". Science Direct. Retrieved 2 April 2023.
- ^ "The Economics Of The Profit Rate". Ideas. Retrieved 2 April 2023.
References
- Albrecht, William P. (1983). Economics. Englewood Cliffs, New Jersey: Prentice-Hall. ISBN 0-13-224345-8.
- Carbaugh, Robert J. (January 2006). Contemporary economics: an applications approach. Cengage Learning. ISBN 978-0-324-31461-8. Retrieved 3 October 2010.
- Lipsey, Richard G. (1975). An introduction to positive economics (fourth ed.). Weidenfeld & Nicolson. pp. 214–7. ISBN 0-297-76899-9.
- Chiller, Bradley R. (1991). Essentials of Economics. New York: McGraw-Hill.
- Mansfield, Edwin (1979). Micro-Economics Theory and Applications (3rd ed.). New York and London: W.W. Norton and Company.
- LeRoy Miller, Roger (1982). Intermediate Microeconomics Theory Issues Applications (3rd ed.). New York: McGraw-Hill.
- Tirole, Jean (1988). The Theory of Industrial Organization. Cambridge, Massachusetts: MIT Press. ISBN 9780262200714.
- Black, John (2003). Oxford Dictionary of Economics. New York: Oxford University Press.
- Jack Hirshleifer; Amihai Glazer; David Hirshleifer (2005). Price theory and applications: decisions, markets, and information. Cambridge University Press. ISBN 978-0-521-81864-3. Retrieved 20 December 2010.
- Perloff, Jeffrey (2018). Microeconomics, Global Edition (8 ed.). Harlow, United Kingdom: Pearson Education Limited. pp. 252–272. ISBN 9781292215624.
External links
- Entrepreneurial Profit and Loss, Murray Rothbard's Man, Economy, and State, Chapter 8.
- OCLC 237794267.