Professional Documents
Culture Documents
Minimum profit necessary to attract and retain suppliers in a perfectly competitive market (see
perfect competition). Only normal profit could be earned in such marketsbecause, if profit was
abnormally high, more competitorswould appear and drive prices and profit down. If profit was
abnormally low, firms would leave the market and the remaining ones would drive the prices and
profit up. Markets where suppliers are making normal profits will neither expand nor shrink and
will, therefore, be in a state of long-term equilibrium.
Economic profit is more likely to occur in the case of a monopoly, as the company in
question has the power to determine the pricing and quantity of goods sold. Such a state
of affairs is largely dependent on the presence of significant barriers to entry, which
prevent other firms from easily entering the market and driving costs down, thereby
disrupting the prominent companys monopoly. In this case, however, governments will
often attempt to intervene in order to increase market competition, often
through antitrust laws or similar regulations. Such laws are meant to prevent large and
well-established companies from using their foothold on the market to reduce prices and
drive out new competition. Some high-profile cases wherein such laws were used against
companies occurred in the late 19th and early 20th century involving Standard Oil, U.S.
Steel (X), and more recently Microsoft (MSFT).
Things to Consider
As demonstrated in the Suzies Bagels example, normal profit does not indicate that a
business is not earning money. Because normal profit accounts for opportunity cost, it is
theoretically possible for a business to be operating at normal profit, develop a new idea
that will improve earnings but was not accounted for in previous opportunity cost
calculations, implement the idea and subsequently exist in a state of improved earnings
while maintaining its normal profit status.
It is also important to consider that implicit cost is an important element of normal
profit calculations, but is also one that is estimated and difficult to determine with
accuracy. As such, it has the potential to be unreliable, which affects the reliability of the
entire calculation. Because of this, it is crucial to take the utmost care when determining
implicit cost.
One should also note that the cost of normal profit can vary between companies and
industries in accordance with the risk of the investment in question.