3.3.4 Normal profits, supernormal profits and losses

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    a) Condition for profit maximisation
    Profit – difference between total revenue and total cost – reward entrepreneurs yield when they take risks (TR – TC)
    Excess of firm’s revenue over cost (opportunity cost of the factors of production used)
    The money a firm has left over after costs are taken away from revenue
    Profit per unit = Average cost – average revenue (AR – AC)
    • Leaves average profit (profit per unit)
    Total profit = average profit * output (number of units sold)
    Profit maximisation occurs when marginal cost = marginal revenue (MC = MR) – each extra unit produced gives no extra loss or no extra revenue
    Profit maximisation – level of output where the difference between total revenue and total cost is largest

    c) Short-run and long-run shut-down points: diagrammatic analysis
    A firm which profit maximises continues to operate in the short run if P > AVC
    This means firms continue to produce in the short run as long as variable costs are covered
    When shutting down, no variable costs are incurred by the firm
    But fixed costs have to be paid whether the firm shuts down or continues to produce – this means fixed costs aren’t considered when a decision to shut down is being made.
    Shut-down point is P < AVC, when variable costs can’t be covered – lowest point on the AVC curve
    When a firm shuts down, it is a short run decision. This means production is only temporarily stopped. However, in the long run, the firm can leave the industry. This will happen when TR < TC

     

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