Normal Profits, Supernormal Profits and Losses 3.3.4

What is Normal Profit?

Describes the level of profit earned by a company or industry that is sufficient to keep it operating, but not so high that it would attract new firms into the industry.

What are total explicit costs?

The actual operating expenses for a business, such as wages, rent, materials.

What are total implicit costs?

They include the opportunity cost of using the owners or investors resources in the business.

Where on a graph are normal costs shown?

Where Average Revenue = Average Costs

What is Marginal profit?

The increase in profits when one more unit is sold.

Where does profit maximisation occur on a curve?

When Marginal Cost = Marginal Revenue

What are 4 objectives for firms that isn’t profit.

• Finance for capital investments and research- retained profits are a key source of finance for businesses undertaking investments & funds for acquisitions.

• Market entry- rising supernormal profits send signals to other producers within a market.

• Demand for and flow of factor resources- resources flow where the risk-adjusted rate of profit is highest.

• Signals about health of the economy.

What are Supernormal Profits?

Refers to a level of profit above and beyond what is needed to cover all costs, including the opportunity cost of resources. Also known as economic profit or abnormal profit.

What situation does supernormal profits represent?

When a firm is making more profit than the minimum required to keep the business operating in the long run.

When does supernormal profit occur?

It happens when price per unit (Average Revenue) exceeds Average Total Cost.

What is the effect of supernormal profits in the long run?

Can attract new firms to enter the market, which eventually leads to increase competition (contestability) and reduced profits towards normal levels.

What are strategies to increase profit?

• Reduce overhead costs (fixed costs) so that average cost per unit falls.

• Increase labour productivity/ outsource some production to lower cost suppliers.

• Move up the value chain- develop new products with a lower price elasticity of demand and higher income elasticity of demand.

• Discount prices if the business estimates that demand is highly price elastic.

• Find new customers in new markets.

What conditions will a firm supply their products in the short-run?

When the price per unit is greater than or equal to average variable cost. (AR = AVC)

Where is the Short-Run Shut-Down price on a curve?

Where price (AR) is less than AVC.

What conditions will a firm supply their products in the long-run?

A business needs to make at least normal profit in the long-run to justify remaining in an industry.

Where is the Long-Run Shut-Down price on a curve?

When price (AR) is less than AC.

Why might a firm survive making a loss?

The managers are satisficing, or where a downturn is seen as temporary and demand is expected to pick up again.