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The Role of Profits and
Markets
Copyright 2005 – Biz/ed
http://www.bized.ac.uk
Profit
• The difference between the costs of
production and revenue earned from
sales
• Profit = TR – TC where:
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TR = Total Revenue (Price x Sales)
Also referred to as Turnover
TC = FC – VC where:
FC = Fixed Costs (overheads)
VC = Variable Costs (direct costs or cost of
sales)
Copyright 2005 – Biz/ed
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Profit
• Drives business objectives:
• Normal profit – the minimum amount
needed to keep a business in a
particular line of production
• Abnormal profit – profit above normal
profit – market power?
• Subnormal profit – below normal
profit – how long can the firm survive?
Copyright 2005 – Biz/ed
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Profit
• Functions of Profit
• Existence of profit suggests:
– Demand buoyant, prices may be
rising, worth entering market
• Profit attracts new businesses
• Profit encourages efficiency
• Profit encourages enterprise,
innovation and risk taking
Copyright 2005 – Biz/ed
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Profit margin = profit / revenue x 100
Margins can be affected by:
•Cost of capital equipment
•Changes in interest payments
•Labour costs
•Type of market
•Top end of the market
•Luxury goods
•High margins/low volume
•Bottom end of the market
•Everyday use
•‘Cheap as chips’
•Low margin/high volume
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Losses
• When costs exceed revenue over a
period
– Caused by temporary downturn in economy
– Caused by external shocks
– Caused by changing tastes/fashions/technology
• Necessity of covering variable costs
• Losses can be sustained:
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Restructuring
Re-financing – shares/loans
Using reserves
Cut costs
Boost sales
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Adding Value
• Difference between the input costs (raw
materials, etc.) and the value placed on
the product/service by the market
• Value added may be tangible –
additional features or intangible – brand
image, style, etc.
• Value Chain – value adding activities in
a product or service
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The Market System
• The Market:
• Consumers represent demand
• Producers represent supply
• Interaction of the two creates the
market
• Changes in supply and demand
conditions cause changes in the
market
Copyright 2005 – Biz/ed
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The Market System
• Price acts as a signal
• Rising prices – goods in shortage,
demand greater than supply – firms
attracted to that line of production by
existence of profit
• Falling prices – existence of surplus,
supply exceeds demand – incentive to
move to more profitable line of
production
Copyright 2005 – Biz/ed
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The Market System
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Factors influencing supply and demand:
Incomes – demand
Costs of production – supply
Advertising – demand
External shocks – supply
Fashions and tastes - demand
Technology – supply
Can you think of others??
Copyright 2005 – Biz/ed
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The Market System
• Changes in supply and demand
• Create surpluses and shortages
• Influence price
• Firms respond to seek profitable
opportunities
• Business flexibility important to
long term survival in changing
markets
Copyright 2005 – Biz/ed