In economic theory normal profit is referred as the minimum level of profit necessary for a firm survival in that line of business. This level of profit enables the firm to incur all its running cost of business. However Accountant calculation is rather different because calculation of profit is based on numerical of past monetary costs and revenues and makes no reference to the concept of opportunity cost. Normal profit arise where Average revenue = Average total cost. Normal profit occurs in all types of market in the short run but in it is only in the long under the perfection competition that normal profit is made.
Generally supernormal profits is any profit above the normal profit and occurs in a situation where AR > ATC . The …show more content…
competitive and contestable market
Perfect competition theory suggests that supernormal profit can only be earned in the short run before the entry of new firms but in the long run normal profit is achieved. This is illustrated in the diagram where a firm earn abnormal profit in the short run. However in the short run not all firms can make supernormal profit .Their profits depend highly on the position of their short run cost curves. Firms can make super profit, normal profit or economic loss depending on their short run costs. In the diagram below, the firm has high short run costs such that its market price is below its average total cost curve.
In the long Run, abnormal profit cannot be sustained as this will attract new firms or expansion of existing firms in the market, causing the demand curve of each individual firm to shift downward at the point where normal profit is achieved. On the other side, firms incurring losses will eventually shut down , causing a shift in the industry supply curve to the left which raise price and enables those left in the market to derive normal profits. This is illustrated in a diagram shown …show more content…
As such firms are forced to keep excess profit to a minimum and emphasizes towards sales maximization rather than profit maximization. 2. Uncompetitive market Abnormal profit is much more prevalent in uncompetitive markets as in a monopoly or oligopoly situation. In these cases, individuals firms have some element of market power. Though monopolists are sole producer in the market, they are price setters or quantity setters rather than price takers. As a result they take the advantage of economic profit in both short and long run.
In the long run, monopolists maintain the existence of economic profit depending on the barriers to entry, to prevent other firms from sapping away their profits. In the oligopoly market, more than one firm can collude thereby restricting supply in order to ensure the price of the product to remain high to ensure all of the firms in the industry achieve an economic profit . The same principle applies in the case of a duopoly market. Thus the firm will produce where MC =MR in order to maximize profit . Given that price (AR) is above ATC at Q, supernormal profits are possible (area PABC). This is illustrated below in a
Generally supernormal profits is any profit above the normal profit and occurs in a situation where AR > ATC . The …show more content…
competitive and contestable market
Perfect competition theory suggests that supernormal profit can only be earned in the short run before the entry of new firms but in the long run normal profit is achieved. This is illustrated in the diagram where a firm earn abnormal profit in the short run. However in the short run not all firms can make supernormal profit .Their profits depend highly on the position of their short run cost curves. Firms can make super profit, normal profit or economic loss depending on their short run costs. In the diagram below, the firm has high short run costs such that its market price is below its average total cost curve.
In the long Run, abnormal profit cannot be sustained as this will attract new firms or expansion of existing firms in the market, causing the demand curve of each individual firm to shift downward at the point where normal profit is achieved. On the other side, firms incurring losses will eventually shut down , causing a shift in the industry supply curve to the left which raise price and enables those left in the market to derive normal profits. This is illustrated in a diagram shown …show more content…
As such firms are forced to keep excess profit to a minimum and emphasizes towards sales maximization rather than profit maximization. 2. Uncompetitive market Abnormal profit is much more prevalent in uncompetitive markets as in a monopoly or oligopoly situation. In these cases, individuals firms have some element of market power. Though monopolists are sole producer in the market, they are price setters or quantity setters rather than price takers. As a result they take the advantage of economic profit in both short and long run.
In the long run, monopolists maintain the existence of economic profit depending on the barriers to entry, to prevent other firms from sapping away their profits. In the oligopoly market, more than one firm can collude thereby restricting supply in order to ensure the price of the product to remain high to ensure all of the firms in the industry achieve an economic profit . The same principle applies in the case of a duopoly market. Thus the firm will produce where MC =MR in order to maximize profit . Given that price (AR) is above ATC at Q, supernormal profits are possible (area PABC). This is illustrated below in a