3.3.4 Normal profits, supernormal profits and losses

PROFIT- DEFINITION

• diff between revenue and costs

CONDITION FOR PROFIT MAXIMISATION

• profit is maximised when TR and TC are furthest apart, w/ TR above TC

• also occurs when MC=MR:

• sometimes, MR and MC may cross at 2 points and thus profit maximising point is where MC rises as it crosses the MR line

NORMAL PROFIT

• return that is sufficient to keep FOPs committed to the business

• costs include level of profit needed to keep the producer in the market and to cover the opportunity cost

• so if firm covers its costs it earns normal profit

• where AC=AR or TC=TR

SUPERNORMAL PROFIT

• if profit is greater than normal profit , it is earning supernormal

• occurs where AR>AC or TR>TC

LOSS

• where firm fails to cover its costs

• AR<AC or TR<TC

SHORT RUN AND LONG RUN SHUT DOWN POINTS

• when a business is making a loss, it may not necessarily be best decision to shut down straight away- depends on AVC

• LR- firm needs to make at least normal profit for them at stay in industry

• SR- should produce as long as their revenue covers their variable costs

• so short run shut-down point is where AVC=AR

LOSS- POS CONTRIBUTION

• AVC<AR then firms should continue production

• each good they make will generate more revenue than it cost for them to make it, and so this will help them to reduce the size of the loss by covering some of the fixed cost (pos contribution)

• so should only shut down when their fixed costs increase

LOSS- NEG CONTRIBUTION

• if AVC>AR then producing more goods will increase the loss- should leave industry immediately

LOSS- DIAGRAM

• if they’re profit maximising, they will produce where MR=MC at the output Q1

• will mean their price is P1 and costs are C1

• making a loss of the shaded area

• but their AVC cost is only C2 and AR>AVC so they will produce in the short run