• explain the concept of profit as used in business;
• explain the concept of normal profit as an element of cost;
• explain the concept of above-normal or super-normal profit;
• find out the amount of profit at different levels of output, given the data on total cost and total revenue;
• locate the position of maximum profit, given the data on total cost and total revenue at different levels of output;
• find out the position of maximum profit, given the data on marginal revenue and marginal cost;
• explain what the producer would do to maximise his profits when he finds :

(a) MR > MC; MR < MC and MR = MC;

• explain that equality of MR and MC alone does not determine the level of output that will fetch maximum profits to the producer ;
• explain that maximum profits are earned when-equality of MR and MC is at such a level of output from which no profitable movement (change in output) is possible;
• state that the position of maximum profits determined by using TR and TC data will be the same as determined by using MR and MC data.

So for calculating his cost of making the table, he must add these imputed costs to money cost. Furthermore, the carpenter has also provided another input - entrepreneurship. While acting as an entrepreneur he is bearing some risks and uncertainties. For this he must get a price which must be some minimum reward (in money) to induce him to make these tables. The minimum reward is actually the opportunity cost of manufacturing the tables. If he does not get this, he will manufacture some other thing and not these tables. And this minimum reward is called normal profit which is the price of entrepreneurship as an input. This must also be included in the cost of manufacturing the tables. Suppose the imputed cost of his own labour, own capital and use of the house is Rs. 400 and his minimum expected profit i.e. normal profit is Rs. 100. The total cost would be Rs. 600 + Rs. 400 + Rs. 100 (Money Cost + Imputed Cost + Normal Profit) = Rs. 1,100. So he gets a surplus ofRs. 200 over and above his total cost. This surplus is called profit. This profit is an addition to the normal profit which is already included in total cost. This is what profit means in micro economics. Let us now distinguish among various levels of profits.

Profit is defined as the excess ofTR over TC. Thus ifTR=TC, level of profit is zero. Zero level of profit is also the same as 'normal profit'. It is because 'normal profit' is a part of TC. In a situation when TR=TC, the producer has realised his minimum expectations in full because he has received back the entire cost incurred by him in full. So, in micro economics, zero profit is the same as normal profit.

If TR is greater than TC (i.e. TR>TC), the level of profit is greater than zero. Since zero profit is the same as normal profit, the 'greater than zero' profit is termed as above normal profit. So a positive (i.e. greater than zero) profit is the same as above normal profit.

We normally use the words 'normal' and 'above normal' pronis m micro economics. There is another term called 'below normal profit'. But 'below normal profit' position is actually a 'loss' position. This situation arises when TR is less than TC (or TR < TC). It means that producer is not in a position to recover all his costs including normal profit. May be his 'normal profit' is partly realised or may be not realised at all. In both situations he is incurring a loss. If such a situation persists and he has no hope of making up his losses he will wind up the production of the commodity at the earliest possible opportunity, m any case a producer will never plan the production of a commodity if his calculations show that he is likely to incur a loss. He will better like to produce a commodity where he at least gets normal profit.

When we say that a producer wants to earn maximum profit, we always mean that he wants to get as much of above normal profits as possible. He will, however, continue to produce so long as he is getting at least the normal profit. Sometimes a situation may arise when he has to be content with just normal profit which is the same as zero profit. In this case, the zero-profit level is the maximum attainable profit level. Therefore, the maximum profit level of a producer may range from zero to any higher level.

• Excess of total revenue over total cost (money cost+imputed cost-hiormal profit) is called profit in economics.
• When total revenue is equal to total cost, the profit is zero and termed as 'normal profit'.
• When total revenue is greater than total cost, the profit is positive and termed as 'above normal profit'.
• When total revenue is less than total cost, the producer faces a loss.

Once a producer has selected a commodity he would like to produce and sell, we have to find out how much quantity of this commodity he should produce and sell so that he gets maximum profit. For this we must get the information about the total cost and total revenue at different levels of output. In table 20.1 imaginary figures are given on level of output, TC and TR at each level of output.

In lesson No. 19 on "revenue" we have pointed out two situations. In one situation a producer is in a position to sell any quantity at a given price. In another situation a producer is able to sell more only at a lower price. Here we are taking the second situation. However, it would make no difference in finding out the maximum profit position if we take the first situation.

Let us first understand how the figures in table 20.1 are worked out. We take the figures of revenue first. In lesson No. 19 we pointed out two market situations. In one situation a producer is in a position to sell any quantity of output at a given price, hi the second situation a producer is able to sell higher quantity only at a lower price, m our example above we have taken the second situation.

Here it is necessary to pomi out mat even if we had taken the first situation it would have made no difference. The process of locating the maximum profit position remains the same. In this situation as output rises TR increases but every successive addition is less than the previous addition because of fall in the price. This tendency is evident from column (3) of the table 20.1.

The figures on total cost have been worked out on the assumption that as more and more output is produced, the average cost of production (TC/output) initially falls and after a certain level of output, starts rising. You must remember that AC first falls and then rises, as more and more output is produced. The pattern adopted of change in cost, as output expands, is the general pattern adopted in micro economic theory. However, it is not the only pattern.

In the last column (3) of the table 20.1 we have taken the excess of total revenue over total cost, which we call profit. The producer wants to get as much of profit as possible. So he wants to produce only that level of output which gives him maximum profit. In column (4) we find that the profit is maximum (Rs. 30) when the level of output is 3 units. So the producer earns maximum profit of Rs. 30 when he produces only 3 units and not any other level of output. Thus, we take the excess of TR over TC at each level of output and select that level of output at which this profit is maximum.

This method of finding the position of maximum profit can be understood more easily with the help of bar-charts.

Area of each of these rectangles show above-normal profit. The rectangle for 5th unit of output is below the X-axis and show 'position of loss'. Since the producer wants to earn maximum profit, he will select that rectangle whose area is maximum and is above the X axis. Such a rectangle in the figure 20.2 is the one with dotted shade. This shows that if the producer produces 3 units, he will get maximum profit equal to Rs. 30. If he produces more or less than 3 units, his profit would be less than Rs. 30.

To sum up, we can say that a producer will compare the total revenue and total cost at each level of output and will decide to produce that level of output at which the excess ofTR over TC is maximum, as this will give him maximum profit.

Profit is maximum when excess of total revenue over the total cost is maximum.

The position of. maximum profit can also be located with the help of data on marginal revenue and marginal cost. As you know, marginal revenue is the addition made to total revenue by producing and selling an additional unit of output, and marginal cost is the addition to totaTcost when an additional unit is produced.

To decide whether to produce and sell an additional unit of output, the producer finds out

whether the production of this unit will fetch him profit.. To find it he compares the margi revenue and marginal cost of producing this additional unit. In this process he may confronted with three alternative situations.

If he finds that the MR is greater than the MC, he will be earning profit on this unit and this will induce him to produce more and he will continue to increase his production so long as MR > MC. But as he increases his level of production, MR will continue to fall if more can be sold only at a lower price. We are once again taking a situation when these sales are possible only at a lower price. Thus the addition to total revenue by each successive unit will go on falling. In other words, total revenue will increase at a diminishing rate with increase in the level of output. By diminishing rate we mean that each new addition to TR is less than the previous addition. On the other hand, as the level of output is increased, marginal cost starts rising after a certain level of output.

Thus, we find that when MR>MC, the producer is induced to produce more as addition production is fetching him above normal profit. But as he produces more, MR starts fallii and MC starts rising, so the initial difference between MR and MC will be wiped out some level of output. This means that the tendency of MR to fall and of MC to rise w ultimately result in a situation where MR would be equal to MC. The figure 20.3 depic these changes :

If he produces even after this point where MC=MR, the MC will be greater than MR and so the production of additional unit will result in a loss because now the addition to total cost is more than addition to total revenue. He would not like to have losses, so he will not produce any more units beyond the point where MR=MC.

Now we take a numerical example to explain how by this method we can locate the position of maximum profit.

Each additional unit of commodity produced makes lesser addition to total revenue. This trend can be observed in the column of MR. When 2 units are produced, addition to total revenue by producing 2^nd unit falls from Rs. 50 to Rs. 49. When 3^rd unit is produced, the addition to total revenue falls to Rs. 47 and so on. On the other hand, as more is produced MC first falls and then rises.

If the producer produces only 1 unit, the finds that MR is Rs. 50 and MC is Rs. 45. So MR>MC and the production of this unit fetches him a profit equal to Rs. 5. This induces him to produce more. When he produces 2^nd unit, he finds that its MR>MC and this fetches him Rs. 9 as above normal profit. So he produces more. For the 3^rd unit also MR>MC, so he produces still more. When he produces 4^th unit he finds MR = MC. For any output less than 4 units MR>MC so he increases production and will stop at the 4^th unit. If he increases production beyond 4^th unit, say, he goes upto 5^th unit, he finds that MC>MR, so the production of this unit results in loss to him. So he will not produce beyond 4^th unk. Any level of output less than 4 units leaves scope for earning more profits and any level of output beyond 4 unit results in lowering of profits. In this way, if he produces less than 4 units, he is not maximising his profits and if he produces more than 4 units, again he is not maximising his profits. However, if he produces only 4 units, he is getting maximum profits. At this level of output MR = MC. Thus, the producer will earn maximum profits if he produces that level of output at which MR = MC.

However, the equality of MR and MC alone does not ensure maximum profit to a producer The equality must be at such a level of output from which no profitable movement in terms of changing the level of output is possible. It may be possible that the MR and MC may be equal at two different levels of output. In such a situation that level of output would be chosen from which any change will reduce the total profit. In other words, profits would be maximised when MR is equal to MC at such a level of output beyond which MR<MC and prior to that MR>MC.

Let us take an example to further clarify this point;

In this example we find that MR and MC are equal at two different levels of output. They are equal when only 1 unit is produced and they are also equal when 4 units are produced. So which level of output should the producer produce. If he decides to produce only 1unit we find that he will not be earning the profit which the production of 2^nd and 3^rd unit can fetch him because for these units MR>MC. So by producing only one unit, he will not maximising his profits, although at this level of output MR=MC. Hence, he will not stop at unit one. He will produce the 2^nd unit, 3^rd unit and will go upto 4^th unit. At 4^th unit MR and MC are again equal. But here besides the equality of MR and MC, we find that further production will result in losses as MR<MC for the 5^th unit and lowering of the total profits. Similarly lesser production will mean foregoing profits as for all the units less than 4 units MR>MC. Thus any change from the level of output of 4 units will reduce his profit. Hence he will get maximum profit if he produces only 4 units.

To sum up, we can say that level of output will give maximum profit to the producer at which the following two conditions are fulfilled :

(i) MR must be equal to MC.

Thus, we now know how a producer selects the level of output giving him the maximum profit. A producer is interested in getting as much of above normal profits as possible. But when a producer is earning above normal profit by producing a commodity, other producers who were not producing this commodity would now be tempted to produce this commodity. As soon as these other producers start producing this commodity the total market supply of this commodity will increase. This would reduce the price. As soon as the price falls, the above normal profits would be reduced. This process will continue i.e., more and more producers will continue to enter into the production of this commodity so long as above normal profit is earned by the already existing producers. Ultimately a situation will be reached When the above normal profit would be wiped out and each producer would earn only normal profit, hi such a situation MC would be equal to MR, TC would be equal to TR and hence AC would be equal to AR.

But a producer may continue to earn above normal profits if new producers are not allowed to produce this commodity.

You must remember that the two alternative approaches of finding the situation of maximum profit, one with the help ofTR and TC and the other with the help of MR and MC, will yield the same result. In other words, the level of output determined wnh the help ofTR and TC, which fetches maximum profit will be the same as determined with the help of MR and MC data. Thus, we can say that when MR=MC the difference between TR and TC will also be maximum, both showing the situation of maximum profit.

• Profit is also maximum when marginal cost is equal to marginal revenue and no further profitable movement of production is possible.
• Above normal profit can persist if there are barriers to the entry of new firms in an industry.