Profits Different types of profit Profit Maximisation Effects of changes in revenues and costs The functions of profit in a market economy Perspectives on profit “What is a man if he is not a thief who openly charges as much as he can for the goods he sells?” Gandhi “Civilization and profits go hand in hand” Calvin Coolidge Economists have different profit concepts Different types of profit Profit measures the return to risk when committing scarce resources to a market or industry Normal profit - is the minimum level of profit required to keep the factors of production in their current use in the long run Normal profits reflect the opportunity cost of using funds to finance a business Sub-normal profit - is any profit less than normal profit (where price < average total cost) Abnormal profit - is any profit achieved in excess of normal profit - also known as supernormal profit Numerical example Price Per Unit (£) Demand / Output (units) Total Revenue (£) Marginal Revenue (£) Total Cost (£) Marginal Cost (£) 50 33 1650 48 39 1872 37 2120 20 -248 46 45 2070 33 2222 17 -152 44 51 2244 29 2312 15 -68 42 57 2394 25 2384 12 10 40 63 2520 21 2444 10 76 38 69 2622 17 2480 6 142 36 75 2700 13 2534 9 166 34 81 2754 9 2612 13 142 32 87 2784 5 2720 18 64 30 93 2790 1 2870 25 -80 2000 Profit (£) -350 Accounting Profit & Economic Profit Accounting Profit The difference between total revenue and costs incurred in the production of goods and services Economic Profit Takes into consideration the opportunity cost of resources used in funding production E.g. £5 million pounds spent in producing an output might have generated a alternative rate of return had it been invested in financial markets. Profit Maximisation Rule Price & Cost MC MR>MC Profits increasing AR=MR Output Profit Maximisation Rule Price & Cost MC MR>MC MR<MC Profits increasing Profits decreasing AR=MR Output Showing Total Profits Price & Cost MC MR=MC AC Maximum Profits AR=MR P1 AC1 Q1 Output Showing Total Profits Price & Cost MC MR=MC AC Maximum Profits AR=MR P1 AC1 Q1 Output Profit maximisation and an increase in demand Price & Price & Cost Cost MC MC P2 P1 AC AC P1 AC AC AR2 AR AR MR2 MR MR Q1 Output Q1 Output Profit maximisation MC Price & Cost AC P1 AC AR MR Q1 Output Profit maximisation following a shift in demand MC AC P2 P1 AC2 AC AR2 MR1 Q1 Q2 MR2 AR1 Output Significance of profits In a market based system profits influence the allocation of resources: (1) Finance for investment: Retained profits remain the most important source of finance for capital investment (2) Market entry: Rising profits send signals to other producers within a market Supernormal profits – market entry Subnormal profits – pressure for market exit Demand for factor resources: Resources flow where the expected rate of return is highest Route maps to higher profits Grow the business – achieve higher sales Margins: High gross profit margin - every extra sale is highly profitable Economies of scale: As a business grows, unit costs reduced through economies of scale. Consumer loyalty and replacement demand the value of each new customer lays not just in the immediate sale, but in future sales as well Defending a high market share against competitors is easier than defending high profit margins But close control of costs is also important