3.3.4 Normal profits, supernormal profits and losses

What is profit?

The difference between revenue + costs

When is profit maximised + explain why?

• MC=MR

• Because this is when the cost of producing an extra unit of output is equal to the revenue gained from selling that extra unit of output

What is normal profit + draw the diagram

• The minimum reward required to keep entrepreneurs supplying their enterprise in the long run → covers the opportunity cost

• When AC = AR

What is supernormal profit + draw the diagram

• Supernormal profit (also called abnormal or economic profit) is the profit above normal profit

• When AR > AC

What is a loss + draw the diagram

• A loss is below the normal profit

• When AC > AR

What is the main decider of whether a firm should shut down?

Average Variable Costs

In the SR, what costs does a firm need to cover in order to not shut down + what does this mean?

A firm needs to cover at least their variable costs to continue producing, meaning their AR must be higher than their AVC

Where is the short-run shutdown point, explain why + draw the diagram

• In the SR firms will shut down when AVC ≥ AR

• This is because the loss a firm keeps if they shut down (AC2, 1, 2, AVC2) is lower than the loss a firm would make if kept on producing (AC2, 1, 3, P2), so they should shut down immediately

Where is the long-run shutdown point, explain why + draw the diagram

• In the LR firms will shut down when AR > AVC

• This is because the loss if a firm keeps on making when producing (ZYWX) is lower than the loss a firm would make if they shut down (ZYUV), so they should keep on producing in the SR + possibly shut down in the LR

Why might firms not shut down after they have reached their shutdown point? (3)

• They might get a loan to cover their losses

• The price fall might be temporary → e.g., a recession

• Demand might rise in the future