Abnormal profit, also known as supernormal profit, refers to the profits exceeding the normal expected returns in a given market or industry. This occurs when a firm’s revenue surpasses all its explicit and implicit costs, including a normal profit, which is the minimum amount necessary to keep resources in their current use in the long run.
Historical Context
The concept of abnormal profit has its roots in classical economic theory, primarily discussed in the context of market structures and competition. It is closely associated with the work of economists like Adam Smith, who spoke about profits above the natural level, and later elaborated by economists such as Alfred Marshall.
Types and Categories
- Short-term Abnormal Profit: Achieved in the short run due to temporary advantages such as sudden spikes in demand or unexpected cost reductions.
- Long-term Abnormal Profit: Sustained over a longer period, usually due to barriers to entry, patents, brand strength, or market power.
Key Events
- Historical Examples: During the Industrial Revolution, many entrepreneurs earned abnormal profits due to technological advancements and lack of competition.
- Modern Examples: Technology firms like Apple and Google have generated sustained abnormal profits due to innovation, brand loyalty, and market dominance.
Detailed Explanations
Mathematical Models
Abnormal profit can be calculated as:
Here is a simple formula to understand this:
- \( \pi_a \): Abnormal Profit
- \( R \): Total Revenue
- \( TC \): Total Costs
- \( \pi_n \): Normal Profit
Charts and Diagrams
graph TD
A[Total Revenue] -->|subtract| B[Total Costs]
A -->|subtract| C[Normal Profit]
B -->|result| D[Abnormal Profit]
C -->|result| D[Abnormal Profit]
Importance and Applicability
Abnormal profit is a critical concept in:
- Monopoly and Oligopoly Analysis: Helps in understanding how firms in less competitive markets can achieve higher profits.
- Investment Decisions: Investors look for firms generating abnormal profits as indicators of strong performance.
- Business Strategy: Firms aim to achieve abnormal profit through innovation, cost leadership, or differentiation.
Examples
- Tech Giants: Companies like Microsoft and Amazon often earn abnormal profits due to strong market positions and continuous innovation.
- Pharmaceutical Firms: Often achieve abnormal profits when they develop new, patented drugs.
Considerations
- Market Dynamics: Abnormal profits attract competition which can erode these profits over time.
- Regulatory Environment: Antitrust laws and regulations may limit the ability to sustain abnormal profits.
Related Terms
- Normal Profit: The minimum profit necessary to keep a firm in business.
- Economic Profit: Total revenue minus total costs, where costs include both explicit and implicit costs.
Comparisons
- Normal vs. Abnormal Profit: Normal profit is a part of a firm’s cost and is the minimum level of profit needed for a company to remain competitive. Abnormal profit, in contrast, is any profit above this level.
Interesting Facts
- Profit Margins: Companies with strong brand identities and patents often sustain abnormal profits longer than those without.
- Competition: In highly competitive markets, abnormal profits are usually short-lived as competitors quickly catch up.
Inspirational Stories
- Apple Inc.: From near bankruptcy in the late 1990s to becoming the world’s most valuable company, Apple’s innovation and brand strength have generated sustained abnormal profits.
Famous Quotes
- “In the business world, the rearview mirror is always clearer than the windshield.” – Warren Buffett
Proverbs and Clichés
- “You have to spend money to make money.”
Expressions
- [“Cash Cow”](https://financedictionarypro.com/definitions/c/cash-cow/ ““Cash Cow””): A business or product that generates a steady return of profits.
- “Money Spinner”: Something that earns a lot of money.
Jargon and Slang
- [“Windfall Profits”](https://financedictionarypro.com/definitions/w/windfall-profits/ ““Windfall Profits””): Unexpected gains in income, often due to external factors.
FAQs
What leads to abnormal profit?
Can abnormal profits be sustained in the long term?
Are abnormal profits legal?
References
- Smith, Adam. “The Wealth of Nations.” 1776.
- Marshall, Alfred. “Principles of Economics.” 1890.
- Schumpeter, Joseph A. “Capitalism, Socialism and Democracy.” 1942.
Summary
Abnormal profit is a fundamental economic concept representing the profits exceeding the normal expected returns in a market. Understanding how these profits are achieved and sustained offers valuable insights for businesses, investors, and policymakers. Whether through innovation, strategic market positioning, or operational efficiency, firms achieving abnormal profit can significantly impact the economy and markets.
