Question

4. What is zero economics profit? B) Why do firms care to achieve it?

Answer 1

A) Profit conjures up immediately the idea of Accounting profit which is Total Revenue - Total Explicit Costs. But Economic profit takes into Account Implicit costs as well as the explicit costs. Zero Economic Profit includes the profit paid to the entrepreneur for using scarce resources, taking risks etc.and total cost is equal to total revenue.

B) Economic profit can serve as a key metric for understanding the state of profits comprehensively within an industry. When a company or companies are achieving economic profit, it may encourage other firms to enter the market because there is profit potential. New entrants contribute more of the product to the market, which lowers the market price of goods and has an equalizing effect on profits. Eventually, the industry reaches a state of normal profit as prices stabilize and profits decline. In the meantime, firms managing for economic profit may take action to obtain a more prominent market position, improve operational performance to lower direct costs, or cut costs to decrease indirect costs. Collectively actions from all industry participants can contribute to the level of revenue and total costs required for the normal profit level.