3.3.4 Normal Profits, Supernormal Profits and Losses Flashcards
What are the conditions for profit maximisation?
Profit maximization occurs when a firm/producer selects the level of output where its economic profit is highest. Economic profit = total revenue - total cost (including both explicit and implicit costs).
- Short run condition: A profit-maximizing firm produces the quantity of output where (MR = MC). In other words, the 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.
- In the long run, in a perfectly competitive market, firms produce where (Price = Marginal Revenue = Marginal Cost). This ensures not only profit maximization but also that firms do not enter or exit the industry in the long run.
Define normal profit
Normal profit is 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. In economic terms, normal profit is when Total Revenue (TR) equals Total Cost (TC), including the opportunity cost of the resources used.
Define supernormal profit (economic profit)
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. In other words, the firm is earning more than enough to cover all costs, including the opportunity cost of the resources used. This situation is generally temporary, as it attracts competition, which can drive down prices and reduce economic profit over time.
Define losses
Losses occur when a firm’s total cost (TC) exceeds its total revenue (TR). In this situation, 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.
