Background
Abnormal profit is a key concept in economics, often synonymous with supernormal profit. It represents the profit above the normal level that is typically expected in a perfectly competitive market. Normal profit refers to the minimum level of profit needed for a firm to remain in business, covering opportunity costs. When firms exceed this level, they earn abnormal profit.
Historical Context
The concept of abnormal profit dates back to classical economic theories. It became particularly significant in the analysis of market structures where firms have some degree of market power, such as monopolies and oligopolies.
Definitions and Concepts
Abnormal profit, also referred to as supernormal profit, occurs when a firm’s total revenue exceeds its total costs, including both explicit and implicit costs. This concept is integral to understanding how different market structures affect firm behavior and profitability.
Major Analytical Frameworks
Classical Economics
In classical economics, it was assumed that in the long run, firms in a competitive market would make zero abnormal profits due to the free entry and exit of firms.
Neoclassical Economics
Neoclassical economics elaborates on the conditions under which abnormal profits can persist. It introduces concepts of market imperfections, such as barriers to entry, that can allow a firm to sustain abnormal profits.
Keynesian Economics
While Keynesian economics is more focused on macroeconomic issues, it also addresses market imperfections and suggests that in the presence of these imperfections, abnormal profits might not be self-correcting.
Marxian Economics
Marxian economics looks at abnormal profit through the lens of class struggle and exploitation. According to Marx, abnormal profits are often the result of exploiting labor under capitalism.
Institutional Economics
Institutional economics emphasizes the role of institutions, such as firms and governments, in shaping market conditions that can lead to abnormal profits.
Behavioral Economics
Behavioral economics might attribute abnormal profits to various cognitive biases and irrational behaviors that result in inefficiencies and market anomalies.
Post-Keynesian Economics
Post-Keynesian perspectives emphasize the importance of uncertainty and historical time in the analysis of profits, including abnormal profits.
Austrian Economics
Austrian economics considers abnormal profit as part of the entrepreneurial discovery process, where innovation and risk-taking are rewarded with profits that exceed the norm.
Development Economics
In development economics, abnormal profits can be a result of market imperfections prevalent in developing economies, including barriers to competition, government regulations, and lack of infrastructure.
Monetarism
Monetarists would examine abnormal profits through the lens of monetary policy impacts on demand, influencing prices and costs in such a way that some firms might persistently earn above-normal profits.
Comparative Analysis
Abnormal profit is more likely in market structures with imperfect competition, such as monopolies and oligopolies, where firms have pricing power and can restrict output to maintain higher prices. In contrast, in perfectly competitive markets, abnormal profits attract new entrants, increasing supply and reducing prices until only normal profits remain.
Case Studies
- Tech Industry Monopolies: The ability of leading technology firms to generate significant abnormal profits can be attributed to network effects, brand strength, and intellectual property, which act as significant barriers to entry.
- Pharmaceutical Industry: Companies often enjoy abnormal profits due to patents and government regulations that limit competition.
Suggested Books for Further Studies
- “Microeconomic Theory” by Andreu Mas-Colell, Michael D. Whinston, and Jerry R. Green
- “Modern Economic Theory” by K.K. Dewett and M.H. Navalur
- “The Theory of Industrial Organization” by Jean Tirole
Related Terms with Definitions
- Normal Profit: The minimum profit necessary for a firm to continue operations.
- Supernormal Profit: Another term for abnormal profit, indicating earnings above normal levels.
- Economics of Scale: Cost advantages that a firm can exploit by expanding their scale of production.
- Market Structure: The organizational characteristics of a market that influence firm behaviour, including monopolistic and perfectly competitive markets.
- Barrier to Entry: Obstacles that make it difficult to enter an industry, often leading to abnormal profits for existing firms.
