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