Normal Profits, Supernormal Profits, and Losses (3.3)

When does Profit Maximum occur?

When a firm or producer selects the level of output where its economic profit is the highest

Economic Profit Calculation

Total Revenue - Total Costs

Condition for Profit Max in the short run?

MR = MC

Condition for Profit Max in the Long run in a perfectly competitive market

P = MR = MC

Reason for the condition for profit max in the long run under a perfect competitive market

Because it ensures both profit maximisation and that firms do not enter or exit the industry in the long run

What is normal profit?

The minimum level of profit required to keep a firm in the industry, as the profit covers all explicit and implicit costs of production but provides no extra income

What is an explicit cost?

The actual monetary payments made by a firm to purchase or hire factors of production

What is an implicit cost?

The opportunity cost of using factors of production already owned by the firm

Examples of an explicit cost

1. Rent

2. Wages

3. Raw Materials

Condition for Normal Profit?

Total Revenue = Total Cost

What is a supernormal profit?

When a firms total revenue exceeds its total cost

Why is supernormal profit usually temporary?

It attracts competition, which can drive down prices and reduce economic profit over time

What are losses?

When a firms total cost exceeds its total revenue

What is the shut down point in the short run and why?

If a firm cannot cover its variable costs as even if it continues to produce and cover some fixed costs, shutting down would minimise its losses

Condition for the firm to keep producing in the short run

AR > AVC

Condition for the shut down point in the short run

AR = AVC

When should a firm remain open in the long run?

AR > AC

When should a firm shut down in the long run?

If AR is equal to or lower than the AC