Profit Flashcards
What if a business is making less than normal profit?
Normal profit is when a firm covers its opportunity cost. If it’s making less than normal profit, it’s no longer covering its opportunity cost - so it will leave the market.
Total Cost includes opportunity cost
In economics, Total Cost doesn’t just include actual physical costs (e.g. raw materials, wages), it also includes opportunity cost (e.g. the opportunity cost of the manager’s time).
Normal profit
Normal profit is when TR = TC. The firm will just cover its opportunity cost, so it will stay in the market.
Losses
Losses are when TR is less than TC. The firm will make less than normal profit, so it will leave the market because it can’t cover its opportunity cost.
Supernormal profit (also known as abnormal profit)
Supernormal profit is when TR is greater than TC. The firm will make more than normal profit.
We now know that our short run shutdown point is where:
B Price = AVC
So, in summary, to work out if a loss-making firm will shut down or not in the short run…first find its profit-maximising quantity, which is where:
B Marginal Cost = Marginal Revenue
So far we’ve seen that in the short run, if a loss-making firm’s AR > AVC, the firm will stay in the market because…
If a loss-making firm’s AR > AVC in the short run, it will still be making some money on each sale. The firm will use this money to pay off its fixed costs, break even and eventually make profit in the long run. So it will stay in the market and wait to make long run profits!
And finally…where AR = AVC is called:
short-run shutdown point
In the long run, average total cost is equal to:
ATC = AVC + 0
So in the long run, above our long run shut down point when AR > ATC:
If AR > ATC, average revenue is above average total cost for each unit sold! So it should stay in the market because it’s making profit on each unit it sells!
So, in summary, in the short run a firm’s shutdown point is where:
AR = AVC
