This is the most commonly used measure of performance. According to economic
theory, in order to maximise profits, firms should be producing up to the level where
marginal cost is equal to marginal revenue (see Chapter 5), in other words, operating at
the point of lowest average cost. If all firms in a market face the same demand conditions,
but one is operating at lower cost than the others, it will be earning higher profits.
Therefore profitability can be used as a measure of performance. There are, however, a
number of problems with the use of profitability as a measure of performance which are
both theoretical and empirical. These problems will be considered later after a discussion
of the concept of profit (see also Chapter 5 which looks at supply, costs and profit).