theme 3 : profit maximisation and output decisions

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8 Terms

1
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what is profit

the difference between total revenue and total costs

2
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why would a firm maximise profits

when the difference between total revenue and total costs is greatest

3
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what is the marginal condition

shows firms where to produce i.e. what level of output to produce

4
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marginal condition explanation

  • if the extra revenue from selling one unit (MR) is greater than the extra cost (MC) the firm will make extra profit from selling the unit, it should always make units where profit can be made (assuming the firms want to profit maximise)

  • where the extra revenue from selling a unit equals the extra cost of producing a unit (i.e. MR=MC) a firm must be making max profit because no extra profit can be made

  • if the extra revenue is less than the extra cost the firm should cut back production because a loss is being made on their extra unit

5
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what is the average condition

shows the firm how much profit (or loss) it is making at a given level of output

6
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average condition explanation

  • if the average revenue (AR) is greater than the average cost (AC) then the firm will be making abnormal profits on each unit

  • if the average revenue (AR) is less than the average cost (AC) then the firm is making a loss on each unit

  • if the average revenue is equal to the average cost then the firm is breaking even on each unit sold and is just making normal profits

7
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normal profits explanation

  • where AR=AC

  • amount of profit that is required to keep resources in their present use in the long run

  • if normal profits are being made in an industry then there is no incentive for firms to join or leave the industry

  • this is because costs in economics includes a reward for the entrepreneurs for being in that industry to cover the risk of being in that industry

8
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supernormal profts explanation

  • profits that in excess of the amount required to keep resources in the industry

  • abnormal profits will continue until other firms join the market (which they will as there is an incentive to join)

  • the extra competition will drive profits back down to normal profit levels