3.3.4 Normal Profits, Supernormal Profits and Losses Flashcards
What is profit maximisation?
When a firm or producer selects the level of output where its economic profit is the highest
Equation for profit?
Profit (π) = TR - TC
What is the condition for profit maximisation in the short run?
MR >= MC
A 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.
What is the condition for profit maximisation in the long run, and under perfect competition?
P = MC = MR
This ensures profit maximisation and also that firms do not enter or exit the industry in the long run
What is normal profit?
The minimum level of profit required to keep a firm in the industry
Equation for normal profit?
TR = TC
(Including the opportunity cost of the resources used)
What is supernormal profit?
When a firm earns more than required to cover all costs, including the opportunity cost of the resources used.
Why is supernormal profit generally temporary?
- attracts competition
- drives down prices
- reduces economic profit over time
What is subnormal profit?
When a firm is not covering all of its costs
Equation for subnormal profit?
TC > TR
What are the implications of subnormal profit?
It can cause a firm to shut down in the short run if it cannot cover its variable costs
When should a firm shut down in the short run?
If it cannot cover variable costs
TR < VC
If the firm continues to produce and cover some of its fixed costs, it would be better shutting down and minimising its losses
When should a firm shut down in the long run?
If they cannot cover their total cost
Because firms enter or exit a perfectly competitive market until profit is driven to 0
When TR = TC
When should a firm exit the industry? (long run)
When TR < TC in the long run
