3.3.4 Normal profits, supernormal profits and losses

Profit maximisation shown through TC & TR curves

Profit maximisation shown through AC & AR curves

Profit maximisation shown through MC & MR curves

Condition for profit maximisation

• Profit is maximised when

  • Gap between TR & TC is at its greatest

  • Gap between AR & AC is at its greatest

  • MC = MR

Normal profit, supernormal profit & losses (the different types of profits can be shown through TC/AC & TR/AR curves)

Normal profit (no gain nor loss)

• TR = TC

• AR = AC

Supernormal profit (more gain than loss - actually have profit)

• TR more than TC

• AR more than AC

Sub-normal profit (profit loss)

• TR less than TC

• AR less than AC

Short-run & long-run shut-down points: diagrammatic analysis

Order of drawing:

1) Draw AR = D

2) MR

3) AC

4) MC

Order of labelling:

1) MC = MR

2) Draw down to x-axis for output - label as Q prof max.

3) Draw up to AC - label y-axis as AC

4) Draw up to AR - label y-axis as AR

The effect of changes in fixed costs & variable costs on cost curves

• Change in Fixed Cost → AC shift

• Change in Variable Cost → AC & MC shifts

Shifts in AR & MR

• If new AR (shift) → new MR too as MR is derived from AR

What are the 3 types of variations of cost/revenue graph - look out for these points from the texts when writing essays

1) change in demand/AR

2) change in FC & VC (change in costs)

3) loss in profit (quite rare)

• Shift AR curve beneath AC curve 

Point of revenue maximisation on the graph

1) Find where MR = 0 (from x-axis)

2) Draw a straight line up to where it meets AR & AC

3) Supernormal profit = AR - AC (same for profit max)

This will then be the value for supernormal profit for revenue maximisation

3 marker + mcq questions COMMON

3 marker:

• Cost & Revenue graph (2 marks)

• Explain why you are shifting the curve you are shifting (ie. VC changes so MC changes ; FC changes so AC changes but FC doesn’t affect MC so MC doesn’t change) (1 mark)

• Therefore, if demand is unchanged, supernormal profit will increase (1 mark)

• Any definitions from the question (1 mark)

Always annotate at the side the size of the supernormal profit just in case

Definition for profit max

MC = MR, objective of firm