Question

Recommend a firm as in investment prospect using microeconomic theory to assess its ability to generate and maintain super-normal profits.

Answer 1

Accounting profit : The profit which considers only explicit costs. (eg. cogs, selling cost, general cost, interest cost, taxes)

Economic profit : The profit which considers both implicit and explicit costs. (implicit costs are the opportunity costs)

If economic profit of a firm is positive, the firm is said to be earning supernormal profits.

If economic profit is zero, the firm is said to be earning normal profits.

There are 4 market structures according to microeconomics

1. Perfect competition

2. Monopolistic competition

3. Oligopoly

4. Monopoly

In case of perfect competition and monopolistic competition, the economic profit is zero in long run. That means, there are no supernormal profit in these market structures. The main reason why these firms can earn only normal profit is that these market structures face minimal barriers to entry.

Barriers to entry are high in oligopoly and very high in case of monopoly. So, for supernormal profit to sustain, one should invest into firms which have monopoly.

It is very difficult to find a firm which has perfect monopoly. In india, IRCTC is the rail corporation which is a monopoly. In the world "luxotica" is close to monopoly in the sunglasses market.