3.3.4 Normal, supernormal profits, losses and shutdown points Flashcards
3.3.4
normal profit
occurs when AR = AC
A firm is making normal profit when its total revenue equals its total costs
it is the minimum level of profit needed to keep resources in their current use in the long run
supernormal profit
when AR > AC
the company is using its resources so effectively that it’s making more money than it could in any other scenario or business setup. This extra profit, beyond what is considered normal or expected
- it increases the insentive fot other firms to enter the industry
profit equation
profit = total revenue - total costs
normal profit in the long run
if a firm cannot make normal profit, it will close in the long run because its revenue is not covering all its costs
normal profit in the short run
in the short run, a firm has fixed costs that it has to pay whether or not it produces any output
so a loss-making firm may not close Immediately and depends on how its revenue compares to its variable costs
when is profit maximised
when marginal cost = marginal revenue
when should a firm increase output
A firm should increase output when marginal revenue (MR) is greater than marginal cost (MC). This is because the revenue from selling an additional unit exceeds the cost of producing it, which increases the firm’s profit.
When should a firm decrease output?
A firm should decrease output when marginal cost (MC) is greater than marginal revenue (MR). This is because the cost of producing an additional unit exceeds the revenue earned from selling it, reducing the firm’s profit.
What is the shutdown price?
The shutdown price is the point where the firm’s revenue just covers its variable costs. If the price falls below this point, the firm can no longer cover its variable costs (like materials and labor), so it’s better to shut down temporarily to avoid further losses.
