4.7 Profit Flashcards
What is profit?
-the difference between total revenue and total costs
What is normal profit?
- Normal profit is the minimum reward required to keep entrepreneurs supplying their enterprise.
-It covers the opportunity cost of investing funds into the firm and not elsewhere.
When is there normal profit?
-when total revenue = total costs (TR = TC).
-Normal profit is considered to be a cost, so it is included in the costs of production.
What is supernormal profit?
-(also called abnormal or economic profit)
-is the profit above normal profit.
-This exceeds the value of opportunity cost of
investing funds into the firm.
When is there supernormal profit?
-This is when TR > TC.
What is the role of profits in a market economy?
-In a free market economy, profit is the reward that entrepreneurs yield when they take risks and make investments.
-An entrepreneur wants to avoid loss and gain profit, which makes them want to innovate, so they can reduce their production costs and improve the quality of their products.
-Entrepreneurs seek to maximise their profits.
How is profit a source of finance for firms?
-can be retained, so they are kept within the firm and not given to shareholders as dividends.
-can be a source of finance for firms if they choose to make an investment.
-It helps them avoid the costs of interest payments if they borrow money
How can profits act as a signal to firms and consumers?
-in markets where firms make supernormal profits, there are likely to be new firms entering the market since the market seems profitable.
-This increases market supply and lowers
the market price.
-This assumes the market is contestable and there are no (or low) barriers to entry.
Where do scarce economic resources generally flow?
-where rewards to investment are higher.
-The factors of production are used in markets where the rate of return is higher.
