Abnormal profit, also known as economic profit or
supernormal profit, is a term used to describe the excess profit earned by a
business or individual beyond the normal level of profit that would be expected
in a given industry or market. In other words, it is the profit earned over and
above the opportunity cost of capital invested in a business.
Abnormal
profit is a key concept in economics and is used to measure the efficiency of a
business. It is the difference between the total revenue generated by a
business and its total cost of production, including both explicit and implicit
costs. Explicit costs refer to the actual expenses incurred by a business, such
as rent, wages, materials, and taxes, while implicit costs refer to the
opportunity cost of resources used by a business that are not reflected in its
financial accounts, such as the owner's time and expertise.
Abnormal
profit can be calculated using the following formula:
Abnormal
profit = Total revenue - Total cost of production - Opportunity cost of capital
If
the result of this calculation is positive, then the business is earning
abnormal profit. If it is negative, then the business is earning a loss.
Abnormal
profit is often seen as a sign of market power, as it indicates that a business
is able to earn higher profits than its competitors due to factors such as a
unique product or service, a strong brand, or a dominant market position.
However, abnormal profit can also be earned through innovation, efficiency, or
superior customer service.
Abnormal
profit is an important concept for businesses, as it allows them to assess
their performance relative to their competitors and to identify areas where
they can improve their efficiency and profitability. It is also important for
policymakers, as it can help to identify industries or markets where
competition is weak and where intervention may be needed to protect consumers
and promote efficiency.
Theories
of abnormal profit
There
are several theories that attempt to explain the existence of abnormal profit
in different market structures. These include:
1.
Monopoly power
The
most straightforward explanation for abnormal profit is that a business has
monopoly power, meaning that it is the sole supplier of a product or service in
a particular market. In this situation, the business is able to charge a higher
price than it would in a competitive market, as there are no substitutes
available to consumers. This allows the business to earn abnormal profit, as it
does not face any competition that would drive prices down to the level of
production costs.
2.
Product differentiation
Another
possible explanation for abnormal profit is that a business is able to
differentiate its product or service from its competitors, either through
quality, design, or branding. This allows the business to charge a premium
price, as consumers perceive its product as being superior to those of its
competitors. As long as the cost of producing the differentiated product is
lower than the price charged, the business can earn abnormal profit.
3.
Economies of scale
Economies
of scale refer to the cost advantages that a business can achieve by increasing
its production volume. In some industries, such as manufacturing or
transportation, the cost per unit of production decreases as the volume of
production increases. This allows larger businesses to earn abnormal profit by
producing more efficiently than smaller competitors. However, this advantage
may be eroded over time as competitors enter the market and achieve similar
economies of scale.
4.
Technological innovation
Technological
innovation can also be a source of abnormal profit, as businesses that are able
to develop new products or processes can earn higher profits than their
competitors. This is because they can charge a premium price for their
innovative products or services, and may also be able to reduce their
production costs through the use of new technologies. However, this advantage
may also be temporary, as competitors may be able to replicate the innovation
over time.
Monopoly Profit: When a company has a monopoly on a product or service, it can charge higher prices than it would in a competitive market, resulting in abnormal profits.
Patent Profit: When a company has a patent on a product or service, it can charge higher prices and earn abnormal profits until the patent expires.
Insider Trading Profit: When individuals trade securities based on non-public information, they can earn abnormal profits that are not available to the general public.
Price Gouging Profit: When a company takes advantage of a natural disaster or emergency to charge excessively high prices for essential goods or services, they can earn abnormal profits.
Strategic Pricing Profit: When a company uses pricing strategies such as price discrimination, bundling, or dynamic pricing, it can earn abnormal profits by maximizing revenue from different customer segments.
Limited Supply Profit: When there is limited supply of a product or service in the market, sellers can charge higher prices, resulting in abnormal profits.
Product Differentiation Profit: When a company offers a unique or differentiated product or service, it can charge higher prices and earn abnormal profits due to the lack of competition.
