3.3.4 Normal Profits, Supernormal Profits + Losses

Question 1

How does a firm maximise profits?

Answer 1

firms should produce up to the level of output where marginal costs (MC) = marginal revenue (MR)

Question 2

What are the types of costs of production?

Answer 2

• explicit costs
• implicitly costs

Question 3

What are explicit costs?

Answer 3

have to be paid e.g. wages, raw materials

Question 4

What are implicit costs?

Answer 4

• opportunity costs of production
• the cost of the next best alternative to employing the firm’s resources

Question 5

Why do implicit costs need to be considered?

Answer 5

entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere

Question 6

How to calculate profit?

Answer 6

Total revenue (TR) - total costs (TC)

(TC include implicit + explicit)

Question 7

When does normal profit occur?

Answer 7

When TR = TC

Question 8

When does supernormal profit occur?

Answer 8

When TR>TC

Question 9

When is the short run shut down point?

Answer 9

• in the short run, if average revenue is higher than average variable costs (AVC) - the firm should keep producing
• if the AR falls to the AVC it should shut down - AR=AVC

Question 10

Short run shut down point analysis

Answer 10

• ## the firm produces at profit maximisation where MC=MR

Question 11

When is the long run shut down point?

Answer 11

• if the AR is higher than AC = firm should remain open
• if the AR is equal to or lower than the AC = the firm should shut down

Question 12

Long run shut down point analysis

Answer 12

• normal profit at AR=ATC = minimum amount a firm needs to stay in the industry in the long run
• anything below AR=ATC = firm shuts down in long run
• the firm continues to produce in the short run as AR>AVC
• shut down point when AR<AVC