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Write a 6 page essay on Types of Profit.Download file to see previous pages... This capital expenditure takes time which cannot be completed in the short-run. Similarly, no existing firm can leave the
Write a 6 page essay on Types of Profit.
Download file to see previous pages...This capital expenditure takes time which cannot be completed in the short-run. Similarly, no existing firm can leave the industry in the short-run. The reason behind this is that whenever a firm sets up in any industry it has to incur some sunk costs. In lay man terms, sunk costs are actually setup costs. These costs are barriers that do not let the firms leave the industry in the short-run as no firm wants to leave the industry without minimizing or cashing in on some of their sunk costs. As we have already discussed, that no firm can be lured into or pushed-out of the industry in the short-run. The reasons that may tempt the other businesses entering into industry are off course profits, as discussed above. There are two types of profit that firm makes in the short run based on its costs and revenue. A firm may be making large profits or break-even in this time-scale. In economic terms break-even is known as normal profit because the calculation includes implicit or opportunity costs, which are not actual cost and hence a firm which is breaking even is making a profit in accounting terms. Normal Profits are usually denoted by AR=AC. Similarly, apart from normal profit a firm might also be making a Supernormal profit denoted by a equation AR>.AC. These profits positions can be shown in the following diagrams:
In figure 1 we see the condition in whi...
In short-run when the firm is earning normal profits, the firm is just covering total costs. Since the TC (Total Cost Calculations) also includes implicit costs like opportunity cost of capital employed, return of capital in alternative uses etc. These are not actual costs and hence breaking even would mean that firm is earning profit which it could earning in alternative businesses and hence there is no motivation for the firm to go out of the industry. The distinction in this situation, for the firm, is AC= AR and thus TC = TR. (Lipsey and Chrystal, 2003)
In figure 2, we see the condition where our assumed manufacturing firm is making an abnormal profit. In this situation the firm earns more than normal profit and hence in this case there is no reason why the firm would leave the industry but instead if it leaves the industry, it won't be able to make as much profit as it is earning in this industry. In the figure 2, the shaded area "pink" is the amount of supernormal profit that our manufacturing firm is earning.
The above two profits positions that a firm could face in the short-run are favorable conditions and hence no rational firm would leave the industry in the prevailing conditions discussed above. However, the problem arises when our manufacturing firm makes an economic loss. An economic loss is a condition when the firm is not able cover its average cost. In this condition, entrepreneurs often face a dilemma whether to continue with the current production or to cease the operation of the firm altogether. However, one interesting point or assumption that we can make here is that even after making an economic loss, sometimes it is feasible for businesses or firms to continue to operate in the industry.
