3.3 - Normal profits, supernormal profits, losses

Question 1

What is profit?

Answer 1

Total revenue - Total costs

> the reward that
entrepreneurs yield when they take risks.

Question 2

What is the condition for profit maximisation?

Answer 2

Marginal costs = Marginal revenue

> firm should continue producing as long as the additional revenue generated from selling one more unit of output is greater than or equal to the additional cost of producing that unit.

Question 3

What is the profit maximising condition for firms operating under perfect competition in the long run?

Answer 3

Price = Marginal costs = Marginal revenue

> ensures not only profit maximisation but also that firms do not enter or exit the industry in the long run.

Question 4

When does profit maximisation occur?

Answer 4

• Profit maximisation occurs when a firm or producer selects the level of output where its economic profit is the highest
  > MR = MC

Question 5

What is normal profit?

Answer 5

• The minimum level of profit required to keep a firm in the industry.
  It is the profit that covers all explicit and implicit costs of production but provides no extra income above those costs.
• Total revenue = Total costs

Question 6

When calculating costs…

Answer 6

Implicit costs and explicit costs are considered

Question 7

What are implicit costs?

Answer 7

• opportunity costs of production
  > This is the cost of the next best alternative forgone to employ the firm’s resources

Question 8

What are explicit costs?

Answer 8

• costs which have to be paid e.g raw materials, wages etc…

Question 9

When does normal profit occur?

Answer 9

Total revenue = Total costs

Question 10

What is supernormal profit?

Answer 10

• Supernormal profit (also known as economic profit) occurs when a firm’s total revenue (TR) exceeds its total cost (TC), including both explicit and implicit costs.
• the firm is earning more than enough to cover all costs, including the opportunity cost of the resources used.
• TR>TC

Question 11

Why is supernormal profit usually temporary, Eg: in perfect competition

Answer 11

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

Question 12

When do supernormal profits occur?

Answer 12

Total revenue > Total costs

Question 13

What is a loss?

Answer 13

• Occur when a firm’s total cost (TC) exceeds its total revenue (TR).
• the firm is not covering all of its costs (including explicit and implicit costs). - Losses can lead to a firm shutting down in the short run if it cannot cover its variable costs.

Question 14

What is the long-run shut down point?

Answer 14

• In the long-run, if the selling price (AR) is higher than the average cost (AC) the firm should remain open (AR > AC)
• if the selling price (AR) is equal to or lower than the average cost (AC), the firm should shut down (AR = AC)
  > firm should exit the industry.

Question 15

What is the short-run shut down point?

Answer 15

• In the short-run, if the selling price (average revenue) is higher than the average variable cost (AVC), the firm should keep producing (AR > AVC)
• If the selling price (AR) falls to the AVC it should shut down (AR = AVC)
  > This is because even if the firm continues to produce and cover some of its fixed costs, it would be better off shutting down and minimising its losses equal to the fixed costs