Economics, 3rd Edition

Profit Maximization: A Numerical Example

Quantity

(Q)

Total  

revenue (

€)

(TR

 

)

Total cost (

€)

(TC

 

)

Profit (

€)

(TR

− TC

 

)

Marginal  

revenue (

€)

(MR

= ΔTR/ΔQ)

Marginal  

cost (

€)

(MC

= ΔTC/ΔQ)

Change in 

profit (

€)

(MR

− MC

 

)

0 litres

0

3

−3

1

6

5

1

6

2

4

2

12

8

4

6

3

3

3

18

12

6

6

4

2

4

24

17

7

6

5

1

5

30

23

7

6

6

0

6

36

30

6

6

7

−1

7

42

38

4

6

8

−2

8

48

47

1

6

9

−3

TABLE 6.5

Thinking at the margin means that famers such as the Grundy’s will consider the marginal cost and marginal revenue of an additional 

cow when considering profit. 

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CHAPTER 6  BACKGROUND TO SUPPLY: FIRMS IN COMPETITIVE MARKETS  155

Normal and Abnormal Profit

In the analysis that follows we make an important assumption related to our earlier discussion of the 

meaning of economic profit. We know that profit equals total revenue minus total cost, and that total cost 

includes the opportunity cost of the time and money that the firm owners devote to the business. A firm’s 

revenue must compensate the owners for the time and money that they expend to keep their business 

going, which is sometimes referred to as normal profit or zero-profit equilibrium.

Consider an example. Suppose that a farmer had to invest 

€1 million to open his farm, which otherwise 

he could have deposited in a bank to earn 

€50,000 a year in interest. In addition, he had to give up another 

job that would have paid him 

€30,000 a year. Then the farmer’s opportunity cost of farming includes both 

the interest he could have earned and the forgone wages – a total of 

€80,000. This sum must be calculated 

as part of the farmer’s total costs. This is referred to as 

normal profit

 – the minimum amount required to 

keep factor inputs in their current use. Even if his profit is driven to zero, his revenue from farming com-

pensates him for these opportunity costs.

Because of the different way accountants and economists measure profit, at the zero-profit equilibrium, 

economic profit is zero, but accounting profit is positive. Our farmer’s accountant, for instance, would 

conclude that the farmer earned an accounting profit of 

€80,000, which is enough to keep the farmer in 

business. In the short run, as we shall see, profit can be above zero or normal profit which is referred to 

as 

abnormal profit

.

If firms are making abnormal profit then there is an incentive for other firms to enter the market to take 

advantage of the profits that exist and this creates a dynamic which moves the market to equilibrium. We 

will look at these dynamic next.