What this lesson teaches
I can explain profit as total revenue minus total cost and find the profit-maximising output where MR equals MC with MC rising.
Syllabus 9570, 2.2.1(a). Objectives of Firms: Firms aim to maximise profits; Profit as the difference between total revenue and total cost; Profit-maximising output occurs at the point when marginal revenue (MR) equals marginal cost (MC) and where MC is rising
Make a guess
A cafe owner takes home $3,000 a month after paying all bills. She could earn $4,000 a month as a manager elsewhere. Is she making a profit, in economic terms?
- Yes, but only a normal profit of $3,000.
- Yes. She earns $3,000 more than her costs each month.
- No. She makes a $1,000 economic loss each month.
Show the answer
No. She makes a $1,000 economic loss each month.
Economists count the $4,000 she gives up as a cost. Her $3,000 is less than her next-best option, so her economic profit is negative.
Profit is total revenue minus total cost, and economists count opportunity cost as a cost.
Profit = total revenue (TR) - total cost (TC).
Economists include opportunity cost in TC. If the owner could earn $1,500 a month working elsewhere, that $1,500 is a cost of running the business, even though no cash is paid.
Normal profit is the minimum profit needed to keep the owner in this business. It is counted as part of cost, so when economic profit is zero, the owner is still earning normal profit.
Supernormal profit is any profit above normal profit. A loss (subnormal profit) means the owner would be better off elsewhere in the long run.
- Profit
- TR - TC, with TC including opportunity cost.
- Normal profit
- Just enough to keep the owner in the business.
- Supernormal profit
- Profit above normal profit.
Worked example: A freelance designer's month
A designer earns $5,000 in a month and pays $3,000 for materials and rent. Her next-best option is a job paying $1,500.
- Accounting profit: $5,000 - $3,000 = $2,000.
- Economic cost includes the $1,500 she gives up: $3,000 + $1,500 = $4,500.
- Economic profit: $5,000 - $4,500 = $500 of supernormal profit.
- She is earning more than in her next-best option, so she should stay in business.
Watch out for this
Zero economic profit means the owner earns nothing.
Zero economic profit means the owner earns normal profit: exactly what they could get in their next-best option.
Check your understanding
A tutor's fees come to $6,000 a month. Her costs, including the $2,500 she could earn teaching in a school, also come to $6,000. What kind of profit is she making?
- Supernormal profit of $2,500, the amount left after paying her cash costs.
- Normal profit, because she earns exactly what her next-best job pays.
- An economic loss, because zero economic profit means she should quit.
Show the answer
Normal profit, because she earns exactly what her next-best job pays.
Right. Economic profit is zero, so she covers her opportunity cost and no more. That is normal profit.