4.7 profit

profit is

the factor payment for entrepreneurship calculated by the difference between total revenue and total costs including explicit and implicit costs

explicit costs

costs that involve directly spending money

Implicit costs

opportunity costs of the factors of production used by the firm, eg the income of the entrepreneur if they worked instead

normal profit

TR = TC

supernormal profit

TR > TC

sub normal profit

TR < TC

profit max when

MC = MR

What is assumed to happen if a firm shuts down in the short run

The fixed costs of production are lost

what profit do firms need to make in the long run to remain in their current use in the long run

in the long run firms need to make at least normal profit

How does a loss making firm determine if they should leave the market in the short run

If they are making losses and their AVC is greater than AR

When AVC > AR why does a firm exit the market

for each unit they sell they are increasing the losses made and therefore will never make up their fixed costs no matter what output they produce and producing additional output is worsening their losses

shutdown condition

AVC > AR

fuctions of profit

an incentive to establish and run any enterprise in a free market economy

source of working capital → inverstment in technology and innovation

as a signialing device in perfect & monopolistic competition to promote the efficient alllocation of reasources within an economy

a source of tax revenue

factor payment for entrepreneurship

what is the difference between what profits can be had in the long run vs short run

in the long run at least normal profit is esential, in the short run sub normal profit may be tollerated as long as not bellow the shut down condition

why might losses be tolerated in the short run

If losses are made but AR > AVC

then the losses from fixed costs can be made up by increasing output in the long run normal/supernormal profit.

However shutting down in the short run would result in definite losses of fixed costs, so

Side note for perfect & monopolistic comp

because of low barriers to entry, some loss-making firms, which are operating bellow the shutdown condition will leave the market. Therfore supply will shift outwards and Therefore, supply will shift to the left and the price will increase (perf) or AR and MR (the demand) will shift outwards as there are more customers that need to be supplied by the firms remaining in the market (monopolistic)

what diagrams can be drawn to show the role of profit

perfect comp making supernormal profit or losses → normal profit (market and individual firm)

monopolistic comp making supernormal profit or losses → normal profit

Why does at least normal profit need to be made in the long run

In the long run all costs are variable therefore output needs to cover fixed and variable costs

Normal profit is also equivalent to the opportunity cost of the entrepreneur’s time, effort and capital. If they are earning less then normal profit it means the entrepreneur would be earning more working for a company so would be better off switching.