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?