8/12/2019 Profit Concept

1/15

8/12/2019 Profit Concept

2/15

A product will be produced only if the total revenue is largeenough to pay wages , interest,rent and a normal profit to theentrepreneur .If the total revenue exceeds all these economic costs, the restgoes to the entrepreneur as an added reward. This return iscalled economic profit or pure profitEconomic profit is above the normal profitEconomic profit is what attracts other producers to aparticular industry.

8/12/2019 Profit Concept

3/15

Profits are the difference between revenuesand costs. In a trade transaction, profit is the

difference between the price at which yousell a good and the price at which you boughtit. Running a business, net profit is what isleft out of turn-over after paying suppliers,

workers, financing institution, and the state.

8/12/2019 Profit Concept

4/15

Consider the case of a competitive market wheremany firms sell basically the same product at thesame price. If they had the same technology andfaced the same input prices (e.g. wages), they

would enjoy similar profit levels. Let's assumethat one specialized supplier introduce a newmachine that is better than the state-of-art, saya faster machine. The suppler sells it to one ofthe firms on the market. This will result in lower

costs per unit of output, thus higher profits.These profits are used, retrospectively, to payfor the investment in the new machine but afterthe pay-back period they can be distributed tofirm's owners.

8/12/2019 Profit Concept

5/15

Consider a market with product differentiation, as this. An R&Dinvestment over the years leads to an improvement of one productfeatures and the management decides to substitute this new model tothe existing one. Let's imagine for simplicity's sake that costs of productare the same as the previous version.Three main effects will increase sales:

1. CONSUMERS who did not buy the good because it did not satisfiedtheir minimum requirements on this feature can now buy, to the extendthe improvement is sufficient at their eyes;

2. consumers who decides by a "top-quality" rule andpositively value the feature could switch from their current provider, tothe extend the overall quality of the new good becomes superior;

3. consumers who decides by a "value-for-money"

rule could switch from their current provider, to the extend the price /quality relationships of the new good becomes more convenient.At the same time, the price of this new version could be set higher thanbefore, so that sales would be braken, unit profits boosted. Overallprofits would soar.

8/12/2019 Profit Concept

6/15

Maximising profits is said to be the objective of all firms. Indeed, it's notalways easy for the management to find out which are the right decisionsthat would maximise them. For instance, short-run profits can be easilypumped up by avoiding maintenance, discretionary costs, investments,that however are necessary of on-going competitiveness, as you canexperiment with this free business game.Moreover, what maximises the "overall profits" is not necessary what

allows to attain the maximum of " profitability ", i.e. the percentage ofprofits to turn-over, as you can better understand by using this model ofmonopoly and comparing two policies: (i) extremely high prices (= highprofitability), (ii) a price set from a mark-up of 15% on costs.In reality, firms do have profits targets , and sometimes they paymanagers for reaching them, but the goals of firms are broader thanprofits alone.Proceeding with other determinants of profits, rising prices ofcompetitors, better sales conditions and skills, a higher overallpricelevel allow for higher prices of the considered firm's products, thusincrease nominal profits to the extent that costs are inelastic, i.e. theyrise less than proportionally to revenues.

8/12/2019 Profit Concept

7/15

Is a component of (implicit) costs and not acomponent of business profit at all. Itrepresents the opportunity cost , as the time

that the owner spends running the firm couldbe spent on running another firm . Theenterprise component of normal profit isthus the profit that a business ownerconsiders necessary to make running thebusiness worth his while it is comparable tothe next best amount the entrepreneur couldearn doing another job.

8/12/2019 Profit Concept

8/15

Economic profit does not occur in perfectcompetition in long run equilibrium; if it did, there wouldbe an incentive for new firms to enter the industry, aidedby a lack of barriers to entry until there was no longer anyeconomic profit.As new firms enter the industry, they increase the supplyof the product available in the market, and these newfirms are forced to charge a lower price to enticeconsumers to buy the additional supply these new firmsare supplying as the firms all compete forcustomers Incumbent firms within the industry face losingtheir existing customers to the new firms entering theindustry, and are therefore forced to lower their prices tomatch the lower prices set by the new firms.

8/12/2019 Profit Concept

9/15

Only in the shortrun can a firm in aperfectly

competitivemarket make aneconomic profit.

8/12/2019 Profit Concept

10/15

Economic profit is, however, much moreprevalent in uncompetitive markets such as in aperfect monopoly or oligopoly situation. In thesescenarios, individual firms have some element ofmarket power: Though monopolists areconstrained by consumer demand, they are notprice takers, but instead either price-setters orquantity setters. This allows the firm to set a

price which is higher than that which would befound in a similar but more competitive industry,allowing them economic profit in both the longand short run.

8/12/2019 Profit Concept

11/15

A monopolist can set aprice in excess of costs,making an economic profit(shaded). The abovePicture shows a Monopolist(only 1 Firm in theIndustry/Market) thatobtains a(Monopoly)Economic Profit. AnOligopoly usually has"Economic Profit" also, butusually faces anIndustry/Market withmore than just 1 Firm(they must share availableDemand at the MarketPrice).

8/12/2019 Profit Concept

12/15

Often, governments will try to intervene in uncompetitivemarkets to make them more competitive. Antitrust(US) orcompetition (elsewhere) laws were created to preventpowerful firms from using their economic power toartificially create the barriers to entry they need toprotect their economic profits. This includes the use ofpredatory pricing toward smaller competitors ]. Forexample, in the United States, Microsoft Corporation wasinitially convicted of breaking Anti-Trust Law and engagingin anti-competitive behavior in order to form one suchbarrier in United States v. Microsoft ; after a successfulappeal on technical grounds, Microsoft agreed to asettlement with the Department of Justice in which theywere faced with stringent oversight procedures andexplicit requirements designed to prevent this predatorybehavior. With lower barriers, new firms can enter themarket again, making the long run equilibrium much morelike that of a competitive industry, with no economic profitfor firms.

8/12/2019 Profit Concept

13/15

In a regulatedindustry, thegovernment examinesfirms' marginal coststructure and allowsthem to charge aprice that is nogreater than thismarginal cost. Thisdoes not necessarily

ensure zero Economicprofit for the firm,but eliminates a "PureMonopoly" Profit .

http://en.wikipedia.org/wiki/Monopoly_profithttp://en.wikipedia.org/wiki/Monopoly_profithttp://en.wikipedia.org/wiki/Monopoly_profithttp://en.wikipedia.org/wiki/Monopoly_profit

8/12/2019 Profit Concept

14/15

Gross profit equals sales revenue minus cost of goods sold(COGS), thus removingonly the part of expenses that can be traced directly to the production or purchaseof the goods. Gross profit still includes general (overhead) expenses like R&D, S&M,G&A, also interest expense, taxes and extraordinary items.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) equalssales revenue minus cost of goods sold and all expenses except for interest,amortization, depreciation and taxes. It measures the cash earnings that can beused to pay interest and repay the principal. Since the interest is paid beforeincome tax is calculated, the debtholder can ignore taxes.Earnings Before Interest and Taxes (EBIT)/ Operating profit equals sales revenueminus cost of goods sold and all expenses except for interest and taxes. This is thesurplus generated by operations. It is also known as Operating Profit Before Interestand Taxes (OPBIT) or simply Profit Before Interest and Taxes (PBIT).Earnings Before Taxes (EBT)/ Net Profit Before Tax equals sales revenue minuscost of goods sold and all expenses except for taxes. It is also known as pre-tax bookincome (PTBI), net operating income before taxes or simply pre-tax Income.Earnings After Tax/ Net Profit After Tax equal sales revenue after deducting allexpenses, including taxes (unless some distinction about the treatment ofextraordinary expenses is made). In the US, the term Net Income is commonlyused. Income before extraordinary expenses represents the same but beforeadjusting for extraordinary items.

Earnings After Tax/ Net Profit After Tax minus payable dividends becomes RetainedEarnings .

8/12/2019 Profit Concept

15/15

THANK YOU