You are on page 1of 6

Profit (economics)

From Wikipedia, the free encyclopedia


Jump to: navigation, search
This article needs additional citations for verification.
Please help improve this article by adding reliable references. Unsourced material may be
challenged and removed. (November 2008)

In economics, the term profit has two related but distinct meanings. Normal profit
represents the total opportunity costs (both explicit and implicit) of a venture to an
entrepreneur or investor, whilst economic profit (also abnormal, pure, supernormal or
excess profits, or simply profit) is, in neoclassical economics at least, is the difference
between a firm's total revenue and normal profit.[1] In classical economics (economic)
profit is the return to the employer of capital stock (machinery, factory, a plough) in any
productive pursuit involving labor. These two definitions are actually the same. In both
instances economic profit is the return to an entrepreneur or a group of entrepreneurs.
Economic profit is thus contrasted with economic interest which is the return to an owner
of capital stock or money or bonds.[citation needed] A related concept is that of economic rent.

Other types of profit have been referenced, including social profit (related to
externalities). It is not to be confused with profit in finance or accounting, which is equal
to revenue minus only explicit costs,[1] or superprofit, a concept in Marxian economic
theory.

Contents
[hide]

• 1 Normal profit
• 2 Economic profit
• 3 Other applications
• 4 Maximizing profits
• 5 See also
• 6 Notes
• 7 References

• 8 External links

[edit] Normal profit


Normal profit is the sum of explicit and implicit costs, and so not a component of
economic profit at all. It represents the opportunity cost for enterprise, since the time that
the owner spends running the firm could be spent on running another firm. The enterprise
component of normal profit is thus the profit that a business owner considers necessary to
make running the business worth his or her while i.e. it is comparable to the next best
amount the entrepreneur could earn doing another job.[1] Particularly if enterprise is not
included as a factor of production, it can also be viewed a return to capital for investors
including the entrepreneur, equivalent to the return the capital owner could have expected
(in a safe investment), plus compensation for risk.

Only normal profits arise in circumstances of perfect competition when long run
economic equilibrium is reached; there is no incentive for firms to either enter of leave
the industry.[2]

[edit] Economic profit


An economic arises when revenue exceeds the opportunity cost of inputs, noting that
these costs include the cost of equity capital that is met by normal profits.

In principle there are three kind of abnormal profit:

• Monopoly rent
• Resource rent
• Intra marginal rent

All enterprises can be stated in financial capital of the owners of the enterprise. The
economic profit may include an element in recognition of the risks that an investor takes.
It is often uncertain, because of incomplete information, whether an enterprise will
succeed or not. This extra risk is included in the minimum rate of return that providers of
financial capital require, and so is treated as still a cost within economics. The size of that
return is commensurate with the riskiness associated with each type of investment, as per
the risk-return spectrum.

Economic profit does not occur in perfect competition in long run equilibrium; if it did,
there would be an incentive for new firms to enter the industry until there was no longer
any profit.[2] Once risk is accounted for, long-lasting economic profit is thus viewed as the
result of constant cost-cutting and performance improvement ahead of industry
competitors, or an inefficiency caused by monopolies or some form of market failure.

In a single-goods case, a positive economic profit happens when the firm's average cost is
less than the price of the product or service at the profit-maximizing output. The
economic profit is equal to the quantity of output multiplied by the difference between
the average cost and the price.

[edit] Other applications


The social profit from a firm's activities is the normal profit plus or minus any
externalities that occur in its activity. A firm may report relatively large monetary profits,
but by creating negative externalities their social profit could be relatively small.

Profitability is a term of economic efficiency. Mathematically it is a relative index – a


fraction with profit as numerator and generating profit flows or assets as denominator.

[edit] Maximizing profits


Profit is defined as the difference in total revenue, TR, and total cost, TC. A firm
maximizes profit by operating at the point where the distance between the total revenue
curve and total cost curve is at its maximum. This point occurs where the slopes of the
two functions are equal. The slope of the TR function is marginal revenue, MR, while the
slope of the total cost function is marginal costs, MC. Thus a profit maximizing firm will
produce that quantity of output at which marginal revenue, MR, equals marginal cost,
MC.[3] This rule applies regardless of market structure. The only "special" case is a firm
operating in a perfectly competitive market. Such a firm operates where price, P, equals
MC. However, this is not a true exception to the rule because an assumption of PC is that
all firms face a perfectly elastic demand curve. With a perfectly elastic demand curve
there is no separate margin revenue curve - MR equals demand and equals price. So with
a PC firm MR = D = P.[4]

[edit] See also


• Economic surplus
• Economic value added
• Externality
• Inverse demand function
• Superprofit
• Surplus value
• Tendency of the rate of profit to fall
• Profit (accounting)
• Profit efficiency
• Profit motive
• Profitability index
• Rate of profit

[edit] Notes
1. ^ a b c Carbaugh, 2006. p.84.
2. ^ a b Lipsey, 1975. pp. 285-259.
3. ^ This assumes that the behavioral assumption of profit maximization applies.
4. ^ MR also equals average revenue, AR.
[edit] References
• Albrecht, William P. (1983). Economics. Englewood Cliffs, New Jersey: Prentice-
Hall. ISBN 0132243458
• Carbaugh, Robert J. (January 2006). Contemporary economics: an applications
approach. Cengage Learning. ISBN 9780324314618.
http://books.google.com/books?id=9Pascy_5HUMC. Retrieved 3 October 2010.
• Lipsey, Richard G. (1975). An introduction to positive economics (fourth ed.).
Weidenfeld & Nicolson. pp. 214–7. ISBN 0297768999.

[edit] External links


• Entrepreneurial Profit and Loss, Murray Rothbard's Man, Economy, and State,
Chapter 8.
• Lester C. Thurow Profits, The Concise Encyclopedia of Economics.

Retrieved from "http://en.wikipedia.org/wiki/Profit_(economics)"


Categories: Profit | Microeconomics | Economics terminology
Hidden categories: Articles needing additional references from November 2008 | All
articles needing additional references | Articles with unsourced statements from October
2010 | Use dmy dates from October 2010

Personal tools

• New features
• Log in / create account

Namespaces

• Article
• Discussion

Variants

Views

• Read
• Edit
• View history

Actions

Search
Navigation

• Main page
• Contents
• Featured content
• Current events
• Random article
• Donate

Interaction

• About Wikipedia
• Community portal
• Recent changes
• Contact Wikipedia
• Help

Toolbox

• What links here


• Related changes
• Upload file
• Special pages
• Permanent link
• Cite this page

Print/export

• Create a book
• Download as PDF
• Printable version

Languages

• ‫العربية‬
• Bosanski
• Català
• Česky
• Cymraeg
• Deutsch
• Español
• Esperanto
• Français
• 한국어
• Hrvatski
• Bahasa Indonesia
• Íslenska
• Italiano
• ‫עברית‬
• Lietuvių
• Македонски
• ‫مصرى‬
• Nederlands
• 日本語
• Norsk (bokmål)
• Norsk (nynorsk)
• Polski
• Português
• Русский
• Simple English
• Slovenčina
• Српски / Srpski
• Srpskohrvatski / Српскохрватски
• Suomi
• Svenska
• తలుగు
• Türkçe
• ‫اردو‬
• Tiếng Việt
• ‫יִידיש‬
• 中文

• This page was last modified on 15 October 2010 at 16:10.


• Text is available under the Creative Commons Attribution-ShareAlike License;
additional terms may apply. See Terms of Use for details.
Wikipedia® is a registered trademark of the Wikimedia Foundation, Inc., a non-
profit organization.
• Contact us

• Privacy policy
• About Wikipedia
• Disclaimers

You might also like