3.3.4 Normal profits, supernormal profits and losses Flashcards
What is profit?
A firm’s total revenue minus total costs.
TR - TC
What are the two types of profit?
- Normal profit
- Supernormal profit
Normal profit
The minimum level of profit needed to keep resources in their current use in the long run.
When is a firm making normal profit?
When its total revenue equals its total costs.
When is a firm making supernormal profit?
When total revenue is greater than its total costs.
What is supernormal profit?
When the revenue generated by a firm is greater than the total costs for the factors of production.
If firms in an industry are making supernormal profit, what will happen?
More firms will enter that industry (because there is an incentive).
Will a firm close if it is not making normal profits?
If a firm can’t make normal profit in the short run, they might not close immediately because they still have fixed costs, which it would have to pay regardless of it is producing (e.g. rent).
However, in the long run, the firm can be released from its fixed costs (e.g. by no longer renting a factory) and will shut down.
What are ‘shut-down points’?
The minimum price a business can operate at to justify remaining in the market.
If a firm’s total revenue is greater than its total variable costs then it will continue to produce in the short term. (This is because any revenue generated above the firm’s variable costs can contribute towarsd paying its fixed costs). If the firm stops production immediately, it’ll actually be worse off.
If a firm’s total revenue is less than its total variable costs then it’ll close immediately. (If it continues to produce, it’ll actually be worse off).
Shut down points on a diagram
- If the price is between P and P1, the firm should continue to produce in the short run.
- If the price falls below P1 the firm should cease production immediately, as its variable costs aren’t being covered.
What is the profit maximisation point?
MC = MR
