3.3.4 Normal Profits, Supernormal Profits and Losses

Question 1

Profit maximisation:

Answer 1

> It occurs when MC = MR. Because before this point producing one more unit would add more to revenue than it would to cost.
It is also maximised when TC and TR are furthest apart (with AR above AC).

Question 2

Normal/Supernormal Profits/Losses:

Answer 2

> Normal profit - the return that is sufficient to keep the factors of production in business. It is the level of profit needed to keep the producer in the market and cover the opportunity cost. It is at the point where AC=AR.
Supernormal/Abnormal Profit - the profit above normal profit. Occurs when AR>AC or TR>TC.
Losses - the firm fails to cover its costs. AR

Question 3

Short-run and Long-run Shutdown points:

Answer 3

> If a business is making a loss they don’t have to shut down straight away.
If AVC However if AVC>AR, then producing more goods will increase the loss. As a result they should leave the market immediately.
In the long run they need to make at least normal profit for them to stay in the industry. But in the short run they should produce as long as their revenue covers variable costs. So the shutdown point is where AVC=AR.

Question 4

Diagrams

Answer 4

(Diagram sheet 4)
> In the first one, the business will continue to produce in the short run. If they are profit maximising they will produce where MR=MC at output Q1. This will mean their price is P1, due to the AR curve, and their costs are C1, due to the AC curve. They are making a loss of the shaded area, but their AVC cost is only C2 and AR>AVC. So they’ll continue producing in the short run.
> In the second one the firm would shut down. If the profit maximise they will produce at output Q1 and sell at a price of P1, with costs of C1. They are making a loss of the box C1P1AB. Here the AVC curve is below the AR curve, so producing Q1 now costs more than the revenue they earn for it, so they will shutdown.