Abnormal Profit

A detailed examination of the concept of abnormal profit in economics.
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In one sentence

Abnormal profit (also called supernormal profit) is profit above normal profit, where normal profit is the opportunity-cost return needed to keep resources in their current use.

Definition (economic profit framing)

Economists typically define abnormal profit using economic profit:

\[ \text{Economic profit} = \text{Total revenue} - (\text{explicit costs} + \text{implicit costs}) \]

If economic profit is positive, the firm is earning abnormal profit. If it is zero, the firm is earning normal profit.

Why it matters across market structures

  • Perfect competition (long run): abnormal profits attract entry; prices fall and abnormal profits tend toward zero.
  • Monopolistic competition: abnormal profits can exist in the short run, but entry and product imitation erode them.
  • Oligopoly/monopoly: abnormal profits can persist if barriers to entry or strategic behavior prevent entry.

Common sources of persistent abnormal profit

  • Patents and intellectual property
  • Network effects and switching costs
  • Brand and reputation
  • Scale economies and learning curves
  • Regulatory barriers (licenses, quotas)
  • Access to scarce inputs or distribution

Entry and profit erosion (intuition)

    flowchart TD
	  P["Abnormal profit observed"] --> E["Entry incentives increase"]
	  E --> N["New firms enter (or expand)"]
	  N --> C["Competition intensifies"]
	  C --> PR["Prices fall and/or costs rise"]
	  PR --> Z["Economic profit tends toward zero<br/>(normal profit)"]
  • Normal Profit: The minimum profit necessary for a firm to continue operations.
  • Supernormal Profit: Another term for abnormal profit, indicating earnings above normal levels.
  • Economics of Scale: Cost advantages that a firm can exploit by expanding their scale of production.
  • Market Structure: The organizational characteristics of a market that influence firm behaviour, including monopolistic and perfectly competitive markets.
  • Barrier to Entry: Obstacles that make it difficult to enter an industry, often leading to abnormal profits for existing firms.

Quiz

### Abnormal profit is also known as: - [x] Supernormal Profit - [ ] Breakeven Profit - [ ] Standard Earned Profit - [ ] Accounting Profit > **Explanation:** Abnormal profit is another term for Supernormal Profit, indicating profit above normal expectations. ### In a perfectly competitive market, abnormal profit is: - [ ] Permanent - [x] Temporary - [ ] Declining - [ ] Non-existent > **Explanation:** In a perfectly competitive market, new entrants usually eliminate abnormal profit, making it temporary. ### Which of the following denotes the profit calculation that includes both explicit and implicit costs? - [ ] Normal Profit - [ ] Accounting Profit - [x] Economic Profit - [ ] Marginal Profit > **Explanation:** Economic Profit calculates by considering total revenue against both explicit and implicit costs. ### True or False: Abnormal profits attract new firms in a competitive market. - [x] True - [ ] False > **Explanation:** True. When new firms see the potential to earn abnormal profits, they are attracted to enter the market. ### Abnormal profit in monopoly is often: - [x] Sustainable - [ ] Minimal - [ ] Absent - [ ] Indistinguishable > **Explanation:** Due to lack of competition, monopoly can sustain abnormal profits over time. ### What is most likely to happen when abnormal profits are observed in a monopolistically competitive market? - [ ] Abnormal profits continue indefinitely - [x] Market attracts new entrants - [ ] Prices rise steadily - [ ] Cost structures become obsolete > **Explanation:** In a market with abnormal profits, new entrants are attracted, leading to competition and normalization of profits. ### Difference between normal profit and abnormal profit? - [ ] An accounting classification - [ ] Zero-sum measure - [x] Profit above the common benchmark - [ ] Both are always positive > **Explanation:** Abnormal profit exceeds the common benchmark profit expected, differentiating it from normal profit. ### In market structures devoid of perfect competition, what is more plausible for firms? - [ ] Increasing product homogeneity - [x] Earning abnormal profits - [ ] Forestalling market entry - [ ] Damaging economic capacities > **Explanation:** Without perfect competition, firms find opportunities to earn abnormal profits due to market power or barriers. ### Alfred Marshall's contributions to the interpretation of profits rest primarily in: - [ ] Myopic demand functions - [x] Determination of normal and abnormal profits - [ ] Arbitrary equilibrium states - [ ] High elasticity interpretations > **Explanation:** Marshall's contribution includes the detailed delineation of normal and abnormal profits as a function of economic competition. ### If economic profit is persistently negative for a firm, what is the typical outcome? - [ ] The firm gains market share - [ ] Abnormal profit rises over time - [x] Exit or downsizing as resources move elsewhere - [ ] Government automatically provides subsidies > **Explanation:** Negative economic profit signals that resources earn more elsewhere, so in competitive markets firms shrink or exit until remaining firms earn normal profit.
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