2.4 Profit Flashcards
Define profit
The difference between total revenue and total costs
Define profit maximisation
Occurs at the level of output which total profit is greatest
Define normal profit
The minimum profit a firm must make to stay in business, which is insufficient to attract new firms to a market (total revenue = total costs )
Define abnormal profit
Profit over and above normal profit aka supernormal profit
Define incumbent firms
Already established firm in a market
What are the roles of profit in an economy?
- The creation of business incentives
- The creation of worker incentives
- The creation of shareholder incentives
- Resource allocation
- Economic efficiency
- Profit as a reward for innovation and risk taking
- Profit as a source of business finance
- Profit sends out a signal about the health of the economy
Why does profit create business incentives?
- Profit maximisation
- Managers work harder
- Incentive for other firms to enter the market
- If there are low barriers to entry/exit market supply will increase
Why does profit create worker incentives?
- Some companies offer performance based pay
- This can be counterproductive as managers tend to receive higher reward
Why does profit create shareholder incentives?
- Higher profit = higher dividends
- Higher profit often leads to higher investment
How does profit impact resource allocation?
- Higher profit provides incentive for producers to enter the market
- Incumbent firms then increase supply
- This means resources are allocated in profitable markets
How does profit impact economic efficiency?
-Large profit shows firms have eliminated the unnecessary costs of production
How does profit impact on reward for innovation?
- If innovation = profit
- Consumers get higher quality products
How is profit a source of finance?
- Helps pay for expansion
- Avoids taking out loans
How does profit affect the health of the economy?
- Higher profit shows increased supply side performance
- Higher productivity
