Supernormal Profit and Market Economy
Supernormal profits are profits made in excess of normal profits i.e. excess profit made over the normal profit, while normal profit is the amount of money made by an organization that is just enough to cover its expenses. Supernormal profits can be in the long run or in the short run. But the firm which innovates and launches new products make supernormal profit in short run. Firms that make supernormal profits in any market are giving indications that the market is viable and that there is an opportunity for money to be made. These prompts new suppliers into the market and the theory of demand and supply play a major role in influencing how the supernormal profits are competed away. However, how fast the supernormal profit is competed away depends on the barriers to entry in the market or industry.
In short run firm which innovates acts as
monopolist and so chooses price constrained by the demand curve. It maximize profits where MR (Marginal Revenue) = MC (Marginal Cost). The supernormal / economic profit is shown in the diagram below.
The supernormal profit per unit is the difference between the average revenue and average cost.
Innovations are the main driving force underlying the economic growth. Innovation needs money and investment. Entrepreneurs and Firms introduce this into the market to earn supernormal profit in short run. Innovation creates demand in the market which gives the firm a monopolistic situation in the market and hence an opportunity to earn the supernormal profit. Once the innovation becomes common, competitors come into the market with same innovation and the demand and supply reaches equilibrium. Then the price of innovation stabilises in market. The firm who is competitive and understand the market continuously goes for R&D and innovation by reinvesting the supernormal profit.
In the new era the firm has changed its approach from “Profit Maximisation” to “Search of Profit”. In competitive market Firm cannot keep itself to the profit maximisation approach with existing technologies. They need to go for “Search of Profit” i.e. innovating and finding new products for the market and hence creating new market base.
