4.1.4.7 Profit Flashcards
(25 cards)
What is profit?
Profit is the difference between total revenue and total costs:
Profit = Total Revenue − 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 in the firm and occurs when TR = TC.
What is supernormal profit?
Supernormal profit (also called abnormal or economic profit) is profit above normal profit. It exceeds the opportunity cost of investment and occurs when TR > TC.
Why is normal profit considered a cost?
Normal profit is considered a cost because it represents the opportunity cost of investing resources in the firm rather than elsewhere.
What is the role of profit in a market economy?
Profit acts as:
- A reward for entrepreneurs taking risks.
- An incentive for innovation and efficiency.
- A signal for resource allocation.
- A source of retained earnings for investment.
Profit in Economics: Key Roles (AQA A-Level Focus)
Profit plays several critical functions in a market economy, aligning with AQA’s emphasis on business objectives, market efficiency, and investment. Here’s how each role works:
- A Reward for Risk-Taking (Entrepreneurship)
Entrepreneurs invest time, money, and effort into businesses with no guarantee of success.
Profit acts as compensation for bearing risks (e.g., startups failing, market fluctuations).
Example: A tech founder earns high profits if their innovation succeeds, offsetting the risk of failure.
AQA Link: Connects to entrepreneurship (Unit 1) and business survival (Unit 3).
- An Incentive for Innovation & Efficiency
Profit motivates firms to:
Innovate (develop new products/processes to gain competitive edge).
Improve efficiency (cut costs to maximize profit margins).
Example: Apple’s high profits reward its R&D in iPhones, incentivizing further innovation.
AQA Link: Ties to dynamic efficiency (Unit 1) and contestable markets (Unit 3).
- A Signal for Resource Allocation
High profits signal that consumer demand is strong in a market, attracting new firms and investment.
Low/losses signal oversupply or declining demand, prompting firms to exit or reallocate resources.
Example: Rising profits in renewable energy signal a shift of resources away from fossil fuels.
AQA Link: Matches price mechanism (Unit 1) and creative destruction (Unit 4).
- A Source of Retained Earnings for Investment
Profits not paid as dividends (retained earnings) fund:
Capital investment (new machinery, technology).
Expansion (entering new markets).
Example: Amazon reinvests profits into AI and logistics, boosting long-term growth.
AQA Link: Relates to investment (Unit 2) and long-run growth (Unit 4).
Evaluation (AQA Higher Analysis)
✅ Strengths:
Profit drives competition, growth, and consumer welfare in free markets.
Critical for economic dynamism (e.g., Silicon Valley’s innovation culture).
❌ Limitations:
Short-term profit maximization may lead to exploitation (e.g., low wages, environmental harm).
Market failures: Monopolies may earn excessive profits without improving efficiency.
Synoptic Tip: Contrast with non-profit objectives (e.g., social enterprises) in Unit 3.
How does profit incentivize entrepreneurs?
Profit incentivizes entrepreneurs to innovate, reduce costs, and improve product quality to maximize their rewards.
What is the difference between normal and supernormal profit?
Normal profit: Covers opportunity cost (TR = TC).
Supernormal profit: Exceeds opportunity cost (TR > TC).
How do profits act as a signal in markets?
High profits signal profitability, attracting new firms to enter the market, increasing supply, and lowering prices (in contestable markets).
What happens to profits in a contestable market?
In a contestable market, supernormal profits attract new entrants, increasing competition and reducing profits over time.
How do retained profits benefit firms?
Retained profits provide a source of internal finance for investment, helping firms avoid interest costs associated with borrowing.
What is the relationship between profit and resource allocation?
Scarce resources flow to markets where profits (returns on investment) are higher, ensuring efficient allocation of factors of production.
Why do entrepreneurs seek to maximize profits?
Entrepreneurs seek to maximize profits to reward themselves for taking risks and to reinvest in the firm for growth and innovation.
What is the opportunity cost of investing in a firm?
The opportunity cost is the return entrepreneurs could have earned by investing resources elsewhere, which is covered by normal profit.
How does profit encourage innovation?
Profit encourages innovation by providing entrepreneurs with the incentive to develop new products, reduce costs, and improve efficiency.
What is the impact of supernormal profits on market entry?
Supernormal profits attract new firms to enter the market, increasing competition and driving down prices and profits over time.
How do profits influence consumer prices?
High profits can lead to lower consumer prices in the long run as new firms enter the market, increasing supply and competition.
What is the relationship between profit and investment?
Retained profits provide firms with funds for investment, enabling growth and innovation without relying on external financing.
How do profits affect the allocation of factors of production?
Factors of production (e.g., labor, capital) are allocated to markets where profits are higher, ensuring resources are used efficiently.
What is the difference between economic profit and accounting profit?
Economic profit: Includes opportunity costs (supernormal profit).
Accounting profit: Only considers explicit costs (revenue minus explicit expenses).
Why is profit maximization important for firms?
Profit maximization ensures firms can reward stakeholders, reinvest in growth, and remain competitive in the market.
How do profits influence market supply?
High profits attract new firms, increasing market supply and driving down prices, while low profits may lead to firms exiting the market.
What is the role of profit in a free market economy?
In a free market economy, profit acts as a reward for risk-taking, an incentive for innovation, and a signal for resource allocation.
How do profits affect barriers to entry?
High profits in a market with low barriers to entry attract new firms, increasing competition and reducing profits over time.
