3.3.4 Normal profits, supernormal profits and losses Flashcards
What are explicit costs?
Explicit costs are the costs which have to be paid e.g raw materials, wages etc.
What are implicit costs?
Implicit costs are the opportunity costs of production
E.g. if an investor puts £1m into producing bicycles and they could have put it in the bank to receive 5% interest, then the 5% represents an implicit cost
Why must implicit costs be considered?
Implicit costs must be considered as entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere
Forumla for profit?
(Total) Revenue - (Total) Costs
Does total costs only include explicit costs?
NO - Total costs include explicit and implicit costs
What is normal profit?
Where TR = TC – also known as breaking even.
How do you “cover” implicit costs?
You “cover” implicit costs by earning enough profit to match the value of what you’re giving up
Basically - ur choosing the best possible thing or something level with the other best choice.
When does a loss occur?
A loss occurs when TR < TC
What are Super Normal Profits?
Supernormal profits is money made past normal profits / breaking even.
It is essentially real profit made beyond covering costs.
Explain the short run shut down point?
In the short-run, if the selling price (AR) is higher than the average variable cost (AVC), the firm should keep producing (AR > AVC)
If the selling price (AR) falls to the AVC it should shut down (AR = AVC)
On a diagram the AC cuve is higher than the AVC curve - price and qty is at the AVC curve so only the variable costs are being covered not the fixed costs.
Explain the long run shut down point?
AR needs to exceed AC to keep open as without AR exceeding AC fixed costs wont be paid for even if AR > AVC.
Why would a firm stay open in the long run?
In the long-run, if the selling price (AR) is higher than the average cost (AC) the firm should remain open (AR > AC)
Why would a firm stay open in the short run?
In the short-run, if the selling price (AR) is higher than the average variable cost (AVC), the firm should keep producing (AR > AVC)
