Profit
Learning Targets:
• Distinguish between economic and normal
profit.
• Explain why a firm will continue even when it
earns zero economic profit?
• Why is economic profit is also called
supernormal profit or abnormal profit.
• Explain positive and negative profit.
Profit
• Profit = TR – TC
• The reward for enterprise
• Profits help in the process of directing
resources to alternative uses in free
markets
Profit
• Economic Profit= Total revenue- economic
cost(implicit cost + explicit cost)
• Normal Profit - the minimum amount
required to keep a firm running
– Revenue= economic cost or economic
Profit = zero
– This is also known as break-even point of a
firm.
• allocation
Why a firm continues to operate even
when earning zero economic profit?
• Note That:
– When a firm is earning normal profit, it has
covered all its opportunity cost (implicit cost) and
will continue to operate
Positive and Negative Profit:
• Economic profit can be zero, positive of negative
• supernormal or abnormal profit:
• Positive economic profit is also referred to as
supernormal or abnormal profit.
• This is because it involves profit over and above
the economic profit.
Profit
To summarize:
• Positive economic profit = TR>economic cost, the
firm supernormal profit
• Zero economic profit= TR=economic cost, the firm
earns normal profit
• Negative economic profit = TR<economic profit,
the firm makes a loss (sub-normal profit)
GOALS OF FIRMS
Learning Targets
• Explain the goal of profit maximization where
the difference between TR and TC is
minimized or when MC=MR
Profit Maximization
• Involves determining the levels of output that
the firm should produce to make profit as
large as possible.
• Yet firms do not always make profit as revenue
is not sufficient to cover all costs
Profit maximization based on TR & TC
Approach
• This is based on the simple principle of TRTC=economic profit
• If the difference between TR and TC is
positive, the firm is making abnormal profit
• If the difference between TR and TC is = to 0,
the firm is making normal profit
• If the difference between TR and TC is
negative, the firm is making a loss
Profit Max. using TR and TC with NO price
control
Profit maximization
TR>TC
Loss minimization
TR<TC
Normal econ profit
TC-TR=0
Profit Max using TR and TC- has price control
Profit maximization
-At point Qmax, profit is maximized
-At point Q1 and Q2, ECON PROFIT=0
(break-even point)
Loss Minimization
-Firm is making a loss as TC>TR,
However, loss is minimized at point
Q1min
Profit Maximization Based of MC & MR
• A firms profit max. rule is to choose to produce
when MC=MR
Why is this so?
-Consider a firm is producing at point Q1 in both
graphs, where MR>MC, if this firm increases its
output by 1 unit, the MR>MC until it intercepts
MR=MC.
-but at Q2, MC>MR, therefore the firm must
cut down its Q output
Explain the relationship between the
given curves.
Profit
Why?
Cost/Revenue
MC
150
145
140
Reduces
total
profit by
this
amount
Total
120
added
Added to
Added
to total
profit
to total
profit
profit
40
30
20
18
If Assume
the firm output
were tois at
The
process
continues
thto
Ifproduce
the firmthe
decides
104
unit,
100
units.
The
MC
of
MC
–
The
cost
of
for
each
successive
MR
–
the
addition
produce
one
more
unit
this
last unit the
would
cost
th –
producing
100
producing
ONE
unit
st
toproduced.
total
revenue
asit
the
101
–
the
addition
more
to
produce
than
unit
is 20.
extra
unit
of
Provided
the
MC is18,
a result
toearns
total
cost
isofnow
in
revenue
(-105)
production
less
than
the
MR
producing
oneit
The
MR received
from
the
addition
to total
this
would
reduce
total
th unit
will
be is
worth
more
unit
ofthe
selling
100
revenue
140
–
firm
profit
andthat
so would
not
expanding
output
as–
output
–to
the
price
150.
The
firm
can
will
128
profit.
beisadd
worth
producing.
difference
received
from
theexpanding
difference
of
it the
isadd
worth
The
profit
maximising
between
two
is
selling
that
extra
the
costthe
and
the
output.
output
isto
where
=
ADDED
total MR
profit
unit.
revenue
received
from
MC
that 100th unit to
profit (130)
MR
100
101
102
103
104
Output
Homework
• Describe alternative goals of firms, revenue
max., growth max., satisficing and corporate
social responsibility.
• Due next week
Test your knowledge
• What are the two approaches max. by firms?
• What is the profit max. rule of firms in each of
the two approaches?