Profit is the reward for entrepreneurial function. Gross profits are the surplus revenue over and above explicit costs. Net profit is the excess of gross profit over explicit and implicit cost. Gross profit contains pure economic profit which arise unforeseen changes in our dynamic economy, causing risk and uncertainty for the entrepreneur, innovations introduced by the entrepreneur and monopoly power enjoyed by the entrepreneur. Thus Gross profits = Total revenue – Total explicit costs. Pure Profit = Gross profit – Implicit cost – Total revenue (Explicit cost + Implicit costs) – depreciation.
Normal profits and Supernormal profits:-
The distinction between normal profit and super normal profits play an important role in economic theory. Normal profit is the reward of entrepreneurial effort. Normal profits are define as the minimum income that an entrepreneur must earn in order, to induce him to remain in the current business or industry, if the entrepreneur does not get this basic minimum he will not production.
This profit is a fixed amount which is included in the cost of production. Normal profit gets distributed over the large volume of output. Normal profit is thus an incentive to produce output.
This profit arises due to the function of the entrepreneur at this profit no existing firms leave the industry nor any new enter the business. The firm or the producer neither expands nor contracts business at this normal profit. Normal profit accrues to a firm in the long period. This long period profit is more for less stable and almost remains constant Normal profit can be expressed in terms of transfer costs. The entrepreneur has certain factors and services of his own which he utilizes in his business. These factors like capital, land and managerially service would have earned him certain amount of remuneration if they had been utilized in other’s business.
Thus the reward of these factors like interest, wage and rent which never receives constitutes the transfer earnings or opportunity cost of the above self-owned factors. Thus the normal profits of an entrepreneur are the above opportunity cost of the self-owned factors. These transfer earnings must be earned by him if he is to stay in the current business or industry.
Supernormal profits are the profits earned by the entrepreneur in excess of normal profits which form a part of the cost of production. Supernormal profit or otherwise called abnormal profit arises due to risks and uncertainty bearing in the business. It also arises because of monopoly advantage and chance factors. According to Hawley an entrepreneur earns abnormal profit because of risks in the business. Abnormal profit arises on account of non- insurable risks. Non insurable risks are not predictable. There risks can not be known beforehand.
If the entrepreneur successfully tides over the risks involved in the business, he wills gane huge profit. This profit arises over the normal profit. Normal profit arises an account of insurable risks. According F.H Knight Profit arises because of the uncertainty conditions in the business. Production is carried on the basis of future anticipation. Goods are produced and sold in the market.
There is a big gap between production and sale. Within this gap period many things change that may upset the anticipation. The demand may decline over night. Thus he may incur loss. But if his anticipation comes true, he will earn windfall profit.
Abnormal profit arises because of the introduction of innovation. An entrepreneur earns constant windfall profit so long as the same innovation is not introduced by others. Abnormal profits disappear when the innovation is universalized. Chance factors also fetch abnormal profit. No amount of human effort is made to earn this abnormal profit. Abnormal profit arising out of chance factors is short-lived. On account of natural calamity agricultural production suffers. Supply falls short of demand. Prices of output rise there by giving rise to profit.
Such calamity is temporary and happens frequently. Abnormal profit also arises due to the nature of market. Under monopoly abnormal profit emerges because of the entrepreneurs’ exclusive power on the production. The entries of others are strictly prohibited.
The monopolist increase. The price by reducing his output. The given rise huge profit. This profit is earned exclusively for monopoly advantage. This abnormal, profit is the profit that arises over and above the normal profit. Abnormal profits are earned without entrepreneurial effort.