3.3.4 Normal profits, supernormal profits and losses

Question 1

Normal profits

Question 2

Supernormal profits

Question 3

Where does the short-run shut down point occur?

Answer 3

• when AVC = AR
• Firms will shut down when AVC>AR because every additional unit sold will add to losses

Question 4

Short run AR > AVC

Answer 4

• If AR > AVC then each additional unit sold = reduce the size of any losses and go towards covering fixed costs.
• The firm will be better off continuing to operate as they will be reducing the size of their losses.

Question 5

Where does the long-run shut down point occur?

Answer 5

• when ATC=AR
• Firms will shut down when ATC>AR because every additional unit sold will add to losses

Question 6

Long run AR>ATC

Answer 6

• If AR>ATC then each additional unit sold will add to profits. The firm will be better off continuing to operate.

Question 7

How do barriers entry such as patents & trademarks

Answer 7

• e.g drugs
• reduce competition = allows drug companies to set a high price & earn enough revenue to research and testing

Question 8

Importance of patents in monopoly

Answer 8

• a patented drug gives the patent holder exclusive rights for a certain period to manufacture and sell that drug in a given market
• Novartis spent nearly $10billion on R&D
  However, not all monopolies have patents (e.g soft tech industries such as video games and app developers) since they can scale their businesses using freely or cheap-available platforms. Also not all patents = supernormal profits

Question 9

Can smaller firms overcome barriers to entry and earn supernormal profit?

Answer 9

Smaller businesses can charge premium prices for bespoke products and are often more nimble in responding to changing consumer tastes and preferences.
- They might also be at less risk of suffering from diseconomies of scale which can cut the profits of larger operators.

Question 10

Example of smaller firms overcoming economies of scale

Answer 10

In the UK food retail sector for example, the rapid growth of Aldi and Lidl reminds us that challenger firms can make serious in-roads into the market share of dominant businesses such as Tesco whose profits (until recently) have suffered as a result of increased contestability and intense price competition.