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Summary Profit
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In depth notes about profit in A level Economics. A* notes.
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38Chapter 5: Profit
5.1 The basics
In Economics, profit is simply defined as:
profit = Total Revenue (TR) —Total Cost (TC)
However,as is always the case, economists don't want it to be so simple. There are three
types of profit:
Supernormal profit: TR > TC
Normal profit: TR = TC
Subnormal profit: TR < TC
Onething that is obvious is that this terminologyis not simply: profit, loss, and break-
even.3 It is important to note that supernormal profit is not the same as accounting
profit. Therefore, if Halliday tutoring generates a profit of 21,000,000 in a year, this
does not mean it has made 21,000,000 supernormal profit.
The reason for this disparity is simple: economics is aimed at determining resource
allocation. To account for this, opportunity cost is also considered to be a part of total
cost. Thus, a firm only makes supernormal profit if it is making more 'accounting' profit
than it could have made using the same resources in their next best scenario. For
example, of Halliday tutoring made 21,000,000 from tutoring but could have only made
2800,000 using the same resources making kebabs, then the business would have a
supernormal profit of 2200,000. Subnormal profit, therefore, means that a firm is using
resources inefficiently; they could be better used elsewhere, and would generate a larger
return in another use. For example, you would be unlikely to start a business that made
a year (the business
a profit of ÉIOO,OOOa year if you had a job offer for 2150,000
would have a subnormal profit of 250,000).
Normal profit, too, has a useful meaning. It means that a firm is making just enough
profit to keep its resources in their current use. That is, a firm is making exactly the
same amount of profit that it could have made using those resources for their next best
alternative.
3TOadd to the confusion, some people use all of these terms interchangeably. People who do this aren't
your friend.
38
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5.2 Showingprofit on a diagram
TCand TRdiagram
In this diagram we can see all three areas of profit quite easily. As the curves represent
total cost and total revenue, calculating the level of profit is just the vertical distance
between the two curves. For example, at an output of (22,it is obvious that TR is greater
than TC, generating supernormal profit. However, at (24,the reverse is true, and the firm
is making subnormal profit. There are only levels of output that generate normal profit
(TR = TC), at QI and (23.
TC/TR
Usin a D=ARMR A M dia ram theo o the
rm
Now, combining the AR, MR, AC, and MC
curves that we saw in chapters
3 and 4, we get
39
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