Supernormal profit

Definition

Supernormal profit refers to the level of profit that exceeds the normal profit, which is the minimum amount necessary to keep a firm operating in a competitive market. This type of profit occurs when a firm's total revenue is greater than the total costs, including both explicit and implicit costs. Supernormal profit is an indicator of a firm's ability to effectively allocate resources and can attract new competitors into the market, leading to potential changes in supply and pricing dynamics.

5 Must Know Facts For Your Next Test

1. Supernormal profit can occur in both short-run and long-run scenarios, depending on market conditions and competition.
2. When firms earn supernormal profits, it signals to other potential competitors that there are opportunities in that market, leading to increased competition.
3. In perfect competition, supernormal profits are typically short-lived as new firms enter the market and drive down prices.
4. Firms with supernormal profits can reinvest those earnings into their operations for growth or innovation.
5. Supernormal profits can lead to market inefficiencies if they persist over time, prompting regulatory scrutiny.

Review Questions

• How does the presence of supernormal profit influence market behavior and competition?
  • The presence of supernormal profit serves as a signal to potential competitors that there are opportunities within that market. This encourages new firms to enter, increasing competition. As more firms join the market, the increased supply typically drives prices down, which can eventually erode supernormal profits over time until they return to normal profit levels.
• Compare supernormal profit with normal profit and explain their significance in a competitive market.
  • Supernormal profit exceeds normal profit, which is the baseline level necessary for a firm to cover its opportunity costs. In a competitive market, normal profit indicates that firms are covering all costs and maintaining operations sustainably. Supernormal profit indicates economic success and efficiency but also signals potential inefficiencies when sustained over time, as it attracts new entrants who could disrupt existing market dynamics.
• Evaluate the long-term implications of sustained supernormal profits for an industry and its impact on consumers.
  • Sustained supernormal profits can lead to negative long-term implications for an industry by attracting excessive competition, which may lead to price wars and reduced profitability for existing firms. This competitive pressure can ultimately drive innovation and lower prices for consumers initially. However, if firms struggle to maintain quality while cutting prices, consumers may face reduced options or lower product quality in the long run. Additionally, if regulatory bodies intervene due to perceived monopolistic behavior or unfair practices from firms with supernormal profits, this could further reshape the industry landscape.

Related terms

Normal profit: Normal profit is the minimum level of profit needed for a company to remain competitive in the market, covering all opportunity costs.

Economic profit:

Economic profit is the difference between total revenue and total costs, including both explicit and implicit costs, which can also indicate supernormal profit when positive.

Market entry: Market entry refers to the process through which new firms enter a market, often encouraged by the existence of supernormal profits in an industry.