2f. Profit

Profit

Profit is calculated by revenue minus costs.

When demonstrating it on a diagram it will be the difference between average revenue and average costs at a certain level of output.

If the average costs are higher than the average revenue, the firm will be making a loss.

To do this, AC, MC, AR, and MR all need to be on a diagram together.

Supernormal vs. normal profit

  • Supernormal or abnormal profit means that a firms AR is above the AC. This is the case on most diagrams.

  • If a firm is making normal profit it means that their AR equals their AC. In accounting this might mean a firm breaks even. In economics however, we are also considering the opportunity cost. Therefore at this point it is likely an accounting profit is being made (for example £25,000) but the owner of the firm could get a job (paying £25,000) instead. Therefore, although there is a profit, it only covers the opportunity cost and we refer to it as normal.

Levels of output for different objectives

Profit maximisation

  • Output is found using MC=MR

  • The price is found by following the output level to the AR curve and then drawing across to the Y axis.

  • Without the costs, this represents the revenue that the firm is making.

  • To find the profit area, draw across to the Y axis from the point at which that level of output crosses the AC curve.

In this case the firm has made supernormal or abnormal profit

Revenue maximisation

  • Output is found using MR=0

  • The same process as before is then used to determine the price, costs and area of profit.

In this case the firm has made supernormal or abnormal profit

Compared the profit maximising point, price is lower, output is higher and the area of supernormal profit is lower. Costs are also likely to be lower at this point.

Sales maximisation

  • Output is found using MR=0

  • Because AR=AC there is no need to find the costs as these will be the same as the price.

In this case the firm only normal profit is made so therefore a shaded area cannot be shown.

Compared the profit max and revenue max, price is lower, output is higher and profit is lower.

Costs are also likely to be lower at this point.

  • Highest possible output without making a loss

Profit satisficing

  • In this instance the output should go between the profit max and revenue max levels.

  • At this point it can be argued that the firm is making close to the maximum profit, so shareholders are happy, but does leave some profit available to be reinvested so the manager can achieve their own personal ambitions for the firm.

  • It’s a form of compromising between stakeholders and managers who hold different ideals usually in between profit and revenue max

    • the divorce between ownership and control

When AR shifts outwards

  • MR shifts out

  • Q will shift outwards ( Q is where MR crosses MC - in profit max)

  • P would increase due to Q shift

  • C depends on the diagram and the AC curve

Think about

  • What happens to output?

  • What happens to price?

  • What happens to profit?

When AR shifts inwards

  • MR shifts in

  • Q will shift inwards ( Q is where MR crosses MC - in profit max)

  • P would fall

  • C could change

  • Profit would fall

Think about

  • What happens to output?

  • What happens to price?

  • What happens to profit?

When MC shifts inwards

  • AC shifts up and centers itself

  • Q falls

  • P goes up

  • C goes up / depends on the graph

  • Profit falls

When MC shifts outwards

  • AC shifts down and centres itself

  • Q rises

  • P falls

  • C falls

  • Profit rises

When AC rises

  • Q stays the same

  • P stays the same

  • C rises

  • Profit decreases

When AC falls

  • Q stays the same

  • P stays the same

  • C falls

  • Profit increases