Students should be able to: Understand the distinction between normal and supernormal profit Explain and illustrate the concept of profit maximisation using marginal cost and marginal revenue

1. What is meant by profit?
Topic 3.3.6

2. What is meant by profit?
Topic 3.3.6
Students should be able to:
• Understand the distinction between normal and
supernormal profit
• Explain and illustrate the concept of profit maximisation
using marginal cost and marginal revenue

3. Key Concepts - Profit
Abnormal profit
Profit in excess of normal - also known
as supernormal or monopoly profit.
Marginal profit
The increase in profits when one more
unit is sold. If MR = £20 and MC = £14
then marginal profit = £6
Normal profit
Normal profit is the transfer earnings of
the entrepreneur i.e. the minimum
reward necessary to keep her in her
present industry
Profit maximisation
Profit maximization occurs when
marginal cost = marginal revenue
Profit per unit Profit per unit (profit margin) = AR – ATC

4. • Normal profit is the minimum profit needed to keep
factor inputs in their current use in the long run.
• Normal profits reflect the opportunity cost of using
funds to finance a business. If you put £200,000 of
savings into a new business, those funds could have
earned a low-risk rate of return by being saved in a bank
account. You might use the rate of interest on that
£200,000 as the minimum rate of return that you need
• Because we treat normal profit as an opportunity cost of
investing financial capital in a business, we include an
estimate for normal profit in the average total cost curve,
thus, if price at least covers AC then a firm is making
normal profits.
Google and Apple’s RevenueNormal Profit

5. • Sub-normal profit
– This is profit less than normal (i.e. price per unit <
average cost)
• Supernormal profits
– Profit achieved in excess of normal profit (known as
abnormal profit).
– Supernormal profits are made when price > AC
– When firms are making abnormal profits, there is
incentive for other producers to enter a market to
acquire some of this profit.
Google and Apple’s RevenueSub-Normal and Super-Normal Profit

6. 1. Finance for capital investment and research: Retained
profits are a key source of finance for businesses
undertaking capital investment + funds for acquisitions
2. Market entry: Rising supernormal profits send signals to
other producers within a market
3. Demand for and flow of factor resources: Resources
flow where the risk-adjusted rate of profit is highest
4. Signals about health of the economy: Rising profits
might reflect improvements in supply-side performance.
They are also the result of higher levels of aggregate
demand for example during an economic recovery.
Profit is an important objective of most but not all firms
The Importance of Profit

7. • The data below is for an owner-managed firm for a given year
– Total revenue £320,000
– Raw material costs £30,000
– Wages and salaries £85,000
– Interest paid on bank loan £30,000
– Salary the owner could have earned elsewhere £32,000
– Interest forgone on capital invested in the business £20,000
• In a simple accounting sense, the business has total revenue of
£320,000 and total costs of £145,000 giving an accounting profit
of £175,000.
• But profit according to an economist should take into account the
opportunity cost of the capital invested and the income that the
owner could have earned elsewhere.
• Taking these two items into account we find that the economic
profit is lower equal to £123,000.
Google and Apple’s RevenueCalculating Economic Profit

8. Google and Apple’s RevenueCalculating Profit
Price Per
Unit
Demand
Total
Revenue
Marginal
Revenue
Total Cost
Marginal
Cost
AR Output (TR) (MR) (TC) (MC)
(£) (Units) (£) (£) (£) (£)
50 33 1650 2000
48 39 1872 37 2120 20
46 45 2070 33 2222 17
44 51 2244 29 2312 15
42 57 2394 25 2384 12
40 63 2520 21 2444 10
38 69 2622 17 2480 6
36 75 2700 13 2534 9
34 81 2754 9 2612 13

9. Google and Apple’s RevenueCalculating Profit
Price Per
Unit
Demand
Total
Revenue
Marginal
Revenue
Total Cost
Marginal
Cost
Total Profit
AR Output (TR) (MR) (TC) (MC)
(£) (Units) (£) (£) (£) (£) (£)
50 33 1650 2000 -350
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

10. Google and Apple’s RevenueCalculating Profit – Explaining the Table
Price Per Unit Demand Total Revenue
Marginal
Revenue
Total Cost Marginal Cost Total Profit
AR Output (TR) (MR) (TC) (MC)
(£) (Units) (£) (£) (£) (£) (£)
50 33 1650 2000 -350
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
The firm moves into profit at an output level of 57 units.
Thereafter profit is increasing because the marginal revenue from selling units is
greater than the marginal cost of producing them.
But once marginal cost is greater than marginal revenue, total profits are falling

11. Marginal profit is the increase in profit when one more unit is sold
MCPrice,
Cost
Output
MR
Marginal
profit is
positive
Positive Marginal Profit

12. MCPrice,
Cost
Output
MR
Marginal
profit is
positive
Marginal
profit is
negative
Marginal profit is the increase in profit when one more unit is sold
Negative Marginal Profit

13. MCPrice,
Cost
Output
MR
Marginal
profit is
positive
Marginal
profit is
negative
Profit
maximised
here
Marginal profit is the increase in profit when one more unit is sold
Marginal Profit =0 at Profit Max Output

14. MCPrice,
Cost
Output
AC
MR
AR
(MR=MC) Q1
P1 is the profit maximising price and output is Q1
P1
Showing Profit Maximisation

15. MCPrice,
Cost
Output
AC
MR
AR
(MR=MC) Q1
Total profit = (P1 – C1) x Q1
P1
C1
Showing Total Profit

16. MCPrice,
Cost
Output
AC
MR
AR
(MR=MC) Q1
This diagram shows supernormal profits i.e. P>AC
P1
C1
Profit
Supernormal Profit
Showing Supernormal Profit

17. Losses – Sub Normal Profits
Topic 3.3.6

18. MC
Output
AC
MR
AR
Q1
P1
Cost and Price
(MR=MC)
Economic Losses – Sub Normal Profit

19. MC
Output
AC
MR
AR
C1
Q1
P1
Cost and Price
(MR=MC)
Economic Losses – Sub Normal Profit

20. MC
Output
AC
MR
AR
C1
Q1
P1
Cost and Price
Economic
Loss
(MR=MC)
Economic Losses – Sub Normal Profit

21. Profits: A Outward Shift in Demand
MC
Price
and
Cost
Output
AC
MR1
AR1
Profit Max: MC=MR
P1
Q1
C1

22. Profits: AR and MR both shift outwards
MC
Price
and
Cost
Output
AC
MR1
AR1
Profit Max: MC=MR
P1
Q1
C1
AR2
MR2

23. Profits: Equilibrium output expands (Q2)
MC
Price
and
Cost
Output
AC
MR1
AR1
Profit Max: MC=MR
P1
Q1
C1
AR2
MR2
Q2
P2
C2

24. Profits: A Higher Price (P2) is charged
MC
Price
and
Cost
Output
AC
MR1
AR1
New Profit Max
P1
Q1
C1
AR2
MR2
Q2
P2
C2

25. Profits: Increase in Supernormal Profit
MC
Price
and
Cost
Output
AC
MR1
AR1
New Profit Max
P1
Q1
C1
AR2
MR2
Q2
P2
C2
Supernormal profit at
price P2 and output Q2

26. Profits: A Rise in Fixed Costs
MC
Price
and
Cost
Output
AC1
MR1
AR1
Profit Max: MC=MR
P1
Q1
C1
Original level of
supernormal
profit at price P1

27. Rise in FC: No Change in Marginal Cost
MC
Price
and
Cost
Output
AC1
MR1
AR1
Profit Max: MC=MR
P1
Q1
C1
AC2

28. No Change in Price but fall in Total Profit
MC
Price
and
Cost
Output
AC1
MR1
AR1
Profit Max: MC=MR
P1
Q1
C1
AC2
C2
Profit after rise in
fixed costs

29. What is meant by profit?
Topic 3.3.6