Unusual Revenue Surplus: Definition, Calculation
In the world of business, profits can vary greatly depending on the market structure a company operates in. Here's a breakdown of how different market structures impact a company's ability to earn supernormal profits, also known as abnormal profits.
In a monopoly, where a single company holds absolute power over quantity and quality, economic profit can persist in the long run. This is due to high barriers to entry and the company's control over a significant share of the market. As the sole purchaser in the industry, a monopolist also has strong bargaining power against suppliers, enabling them to get a lower price for inputs.
However, in a perfectly competitive market, where many firms sell identical products, no single firm has the power to influence market price. While some firms may earn abnormal profits in the short run, these will not persist in the long term due to new entrants bringing in new supplies and forcing prices down.
In an oligopoly, where a small number of firms dominate the market, companies can generate positive economic profit through differentiation. The firms able to generate abnormal profits over a longer period are typically the dominant firms that have established barriers to entry, enabling them to maintain market power and keep prices above average total cost. These firms exploit limited competition and strategic behaviors to sustain such profits.
It's important to note that economic profit is calculated by subtracting explicit costs and implicit costs from total revenue. Explicit costs include total variable costs and total fixed costs, and can be found on the income statement along with total revenue. Implicit costs, on the other hand, represent the opportunity costs of using the firm's current resources, such as the cost of buying a production machine instead of renting it. These implicit costs are not included in the income statement.
Companies may try to hide economic benefits to reduce competitive pressure from new entrants and government anti-competitive investigations. Entry of new competitors in the market can lower market prices and reduce profits for a company with abnormal profit.
In summary, entry barriers are among the critical factors for sustaining supernormal profit in the long run. Understanding these barriers and the market structures they operate in can provide valuable insights for businesses and policymakers alike.
