StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

The Profit Position of a Firm in the Industry - Essay Example

Cite this document
Summary
The paper entitled 'The Profit Position of a Firm in the Industry' presents manufacturing that may face an economic profit or loss in the short run. A short-run period is when no new firm enters or leaves the industry, so the number of firms is fixed…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER94.8% of users find it useful
The Profit Position of a Firm in the Industry
Read Text Preview

Extract of sample "The Profit Position of a Firm in the Industry"

AR = MR MC = MR AC P,C,R Pe MR Quantity Fig Normal Profit Quantity AR = MR AC MC = MR P,C,R Pe MR C MR Fig 2: Supernormal Profit A manufacturing may face an economic profit or economic loss in the short-run. A short-run is a period of time where no new firm enters of leaves the industry and hence the number of firms is fixed. For example, if there are 21 firms operating in, let's say a manufacturing business then in the short-run this number cannot be changed. The logic behind the fixed number of firms in the short-run is that this time period is too short to lure new firms enter into the industry, if the industry is making a profit as there are lot of setup costs and capital expenditure that have to be incurred in order to join this industry. 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 which the firm is making a level of profit that is just enough to persuade the firms to stay in the industry in the short-run but not enough to attract new firms. 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. The reasons behind this may be economical or non-economical. However, in this case, we will restrict our discussion to economic reasons only. (Sloman, 2002) A situation in which a manufacturing firm experiences a loss is known as subnormal profits. This means that the firm is producing where AC > AR. In simple words, in this situation, a firm incurs more cost than revenue and hence continuing to operate in this situation, gnaw the firm's profits. In the short-run, our manufacturing firm will continue to operate as long as it is covering the CV i-e till the price to the minimum of AVC (Average Variable Cost) as shown in the figure 3. This is also called the shutdown point i-e if the price falls below this point, the firm will shutdown in the short-run as it will not be covering even the VC or variable costs. MC = MR Quantity AR = MR AC P,C,R Pe MR C MR Fig 3: Economic Loss AVC d MR Source: (Pindyck and Rubinfield, 2008) In the above diagrams, we can clearly see that AVC is below AC. Since, AC is a sum of AFC and AVC, that is why AVC is always below AC. We can prove this concept through mathematical calculations. AC = AFC + AVC AVC = AC - AFC Since AC is always positive and when you subtract it from AC, the value of AVC will always be less than AC and hence AVC curve will be below AC curve. The AVC curve will come closest to AC curve at very high quantities because at this point the Average Fixed Cost will closest to zero because the cost is being absorbed by so many units. For e.g. if Fixed Cost is $100 and 10,000 units are being produced, then AFC will be 100/10000 = $0.01. This proves that AVC curve will be always below AC curve, because of the fixed cost factor. However, coming back to the original discussion, the firm will continue to produce as long as it is covering its AVC (average variable cost), or in other words, as long as price is above is greater than the minimum point AVC curve. Let's assume that figure 3 is the diagram of the cost condition that our manufacturing firm is experiencing. In the diagram, we clearly see the minimum point of AC curve is labeled "d". At point'd', MC meets AVC curve, or it is the point of intersection between the MC curve of the firm and its AVC curve. So, in this condition our firm will continue to produce despite making economic losses as long as price is greater than AVC or minimum point of AVC curve. The larger the size of the firm, the bigger chance that it will be able to face losses and its price is likely to be greater than the minimum of AVC and hence it will be covering a bigger part of fixed cost. Similarly, large firms are usually backed by large capital and funds and hence they can endure the loss situation more efficiently than a smaller firm. Hence, the larger the firm is, the greater chances are there that it is going to stay in the industry even after making economic losses as there is more chances that its price will be greater than minimum point and AVC curve. However, if we talk about long-run, the firms will only make normal profit in the long-run. In the long-run firms can freely enter or leave the industry. In case, the firm is making large supernormal profits, other firms will see to it and enter the industry in the search of high profits level. However, their entry is going to distort the market equilibrium by increasing supply. This will shift the prices down until the profit levels of the firms are going to decrease to normal profit and some firm who were already making supernormal profits, the price reduction is going to leave them making losses and in the long run, where there is no compulsion for the firms to stay in the industry, the loss making industries are going to leave the industry. This will bring the industry to situation where only the normal profit is being made. Similarly, losses are going to clean the industry from firms who are not covering their AVC. This is going to reduce the supply in the industry and in turn prices will rise. This price rise is going to convert the losses into normal profits and this recovery is going to lead all the firms making normal profits. (Brue and McConnell, 2001) This is how the industry time period and firm's cost curves determine the profit position of a firm in the industry. References: Campbell McConnell and Stanley Brue. Economics. McGraw-Hill Companies; 15th edition (October 15, 2001) Richard Lipsey and Alec Chrystal. Oxford University Press; 10th Revised edition (28 Aug 2003) John Sloman. Economics. Prentice Hall; 5 edition (19 Dec 2002) Robin Pindyck and Daniel Rubinfield. Microeconomics. Prentice Hall; 7 edition (June 21, 2008) Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Types of Profit Essay Example | Topics and Well Written Essays - 1500 words”, n.d.)
Types of Profit Essay Example | Topics and Well Written Essays - 1500 words. Retrieved from https://studentshare.org/miscellaneous/1508698-types-of-profit
(Types of Profit Essay Example | Topics and Well Written Essays - 1500 Words)
Types of Profit Essay Example | Topics and Well Written Essays - 1500 Words. https://studentshare.org/miscellaneous/1508698-types-of-profit.
“Types of Profit Essay Example | Topics and Well Written Essays - 1500 Words”, n.d. https://studentshare.org/miscellaneous/1508698-types-of-profit.
  • Cited: 0 times

CHECK THESE SAMPLES OF The Profit Position of a Firm in the Industry

Adopting a Simple Profit-Maximizing Perspective Can Have Positive Impacts for a Firm

The first model is the structure conduct performance model (SCP) that describes the extent of concentration in the industry, decides the behavior of the firm and its profitability (Stierwald, 2009).... The second model is the effect model, which states that within the industry, the firms are heterogeneous and they can be differentiated with their efficiency level.... The paper "Adopting a Simple Profit-Maximizing Perspective Can Have Positive Impacts for a firm" discusses that firms should make such decisions that help the company to maximize the value of the company and make a strategy that will have a positive impact for the firm and its owners....
8 Pages (2000 words) Assignment

Principles of Microeconomics

Though that may be the case, but sometime, a firm may not enjoy the domestic monopoly power, rather face an intense competition from other oversee producers.... Those are at a disadvantage are the low income consumers who might be exploited by such a monopoly market where prices are a bit higher (Mckenzie 2008) Thought to producer high prices contribute to increase in the profit made by the firm.... For instance the government can opt to create a monopoly over an industry....
5 Pages (1250 words) Research Paper

Simple Profit Maximizing Perspective

Total costs include all expenses incurred by a firm in buying the inputs required in the production process (Grant, 2002).... As illustrated in the diagram below, the curve illustrates profit maximization point for a firm in a perfect competition market.... The goals of a firm are crucial as they are the elements that lay a foundation for understanding, predicting and interpreting different profit behaviors experienced by different firms.... The agency theory gives the relationship between the ownership structure of a firm and the profit maximization objective....
8 Pages (2000 words) Essay

Corporate performance, abnormal profits and sectoral differences

Some assumes that performance of the firm is determined by industry in which it operate while others believe that performance of a firm is specific to its own internal factors (Lecture 4, 2012).... Firms are endowed with different resources and this could result to improved performance of the company regardless of the industry in which it operates (Rosenzweig, 2007, p.... Regardless of the industry in the firm is operating, the level of their performances can be determined in relation to how much benefits can be obtained from the capital employed....
4 Pages (1000 words) Essay

Microeconomic of the Firm

hut-down Point for a firm (20 points) ... Some of the key issues to consider in determining this point include; the relative position of the average variable cost which is always at its minimum for this condition.... Some of the industries with such assumptions include clothing and textile, Cosmetics, electrical and electronics industry among others.... The paper "Microeconomic of the firm" will explain what this means.... hen will the competitive firm shut down in the short run?...
6 Pages (1500 words) Essay

Economic Profit or Loss Evaluation

n figure 1, we see the condition in which the firm is making a level of profit that is just enough to persuade the firms to stay in the industry in the short-run but not enough to attract new firms.... The report "Economic Profit or Loss Evaluation" presents a macroeconomic analysis of the theoretical evaluation of the industry's profit/loss within a period.... Manufacturing may face an economic profit or loss in the short-run when no new firm enters or leaves the industry, and hence the number of firms is fixed....
5 Pages (1250 words) Report

Frictional Profit Theory and Innovation Profit Theory

the industry is often characterised by a large number of buyers and sellers so that there is no scope to earn a super-normal profit.... The paper "Frictional Profit Theory and Innovation Profit Theory" states that generally, though disequilibrium conditions are corrected with time, restriction of innovative activities solely depends upon the efficiency of the researchers employed by a firm.... While the former forms of profits arising out of market disequilibrium, the latter occurs due to a firm's capabilities of making successful innovations....
8 Pages (2000 words) Coursework

Simple Profit Maximizing Perspective

Total costs include all expenses incurred by a firm in buying the inputs required in the production process (Grant, 2002).... As illustrated in the diagram below, the curve illustrates the profit maximization point for a firm in a perfect competition market.... Profit maximization perspectivesTotal revenue- total costTotal revenues are derived from the amount a firm receives from the sale of its output.... a firm is considered profitable when the total revenues exceed the total costs....
10 Pages (2500 words) Essay
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us