Profits Different types of profit Profit Maximisation Effects of changes in revenues and costs The functions of profit in a market economy

Perspectives on profit “What is a man if he is not a thief who openly charges as much as he can for the goods he sells?” Gandhi “Civilization and profits go hand in hand” Calvin Coolidge

Economists have different profit concepts

Different types of profit Profit measures the return to risk when committing scarce resources to a market or industry Normal profit - is the minimum level of profit required to keep the factors of production in their current use in the long run Normal profits reflect the opportunity cost of using funds to finance a business Sub-normal profit - is any profit less than normal profit (where price < average total cost) Abnormal profit - is any profit achieved in excess of normal profit - also known as supernormal profit

Numerical example Price Per Unit (£) Demand / Output (units) Total Revenue (£) Marginal Revenue (£) Total Cost (£) Marginal Cost (£) Profit (£)

Accounting Profit & Economic Profit Accounting Profit The difference between total revenue and costs incurred in the production of goods and services Economic Profit Takes into consideration the opportunity cost of resources used in funding production E.g. £5 million pounds spent in producing an output might have generated a alternative rate of return had it been invested in financial markets.

Profit Maximisation Rule Output Price & Cost AR=MR MC MR>MC Profits increasing

Profit Maximisation Rule Output Price & Cost AR=MR MC MR>MC Profits increasing MR<MC Profits decreasing

Showing Total Profits Output Price & Cost AR=MR MC MR=MC Maximum Profits P1 AC Q1 AC1

Showing Total Profits Output Price & Cost AR=MR MC MR=MC Maximum Profits P1 AC Q1 AC1

Profit maximisation and an increase in demand Output Price & Cost MR P1 AC Q1 AC MC AR Output Price & Cost MR P1 AC Q1 AC MC AR MR2 AR2 P2

Profit maximisation Output Price & Cost AR MC AC MR P1 AC Q1

Profit maximisation following a shift in demand Output AR1 MC AC MR1 P1 AC Q1 AR2 MR2 Q2 P2 AC2

Significance of profits In a market based system profits influence the allocation of resources: (1) Finance for investment: Retained profits remain the most important source of finance for capital investment (2) Market entry: Rising profits send signals to other producers within a market Supernormal profits – market entry Subnormal profits – pressure for market exit Demand for factor resources: Resources flow where the expected rate of return is highest

Route maps to higher profits Grow the business – achieve higher sales Margins: High gross profit margin - every extra sale is highly profitable Economies of scale: As a business grows, unit costs reduced through economies of scale. Consumer loyalty and replacement demand - the value of each new customer lays not just in the immediate sale, but in future sales as well Defending a high market share against competitors is easier than defending high profit margins But close control of costs is also important