Edexcel A Level Economics A:复习笔记3.3.4 Normal Profits, Supernormal Profits & Losses

Condition for Profit Maximisation

  • To maximise profit firms should produce up to the level of output where marginal cost (MC) = marginal revenue (MR)

Calculations To Demonstrate the Profit Maximisation Rule

Output MR (£) MC (£)  Addition to Profit
5 50 32 +18
6 50 36 +14
7 50 50 0
8 50 68 -18

 

Observations

  • With the 7th unit of output, MC = MR & no additional profit can be extracted by producing another unit
  • Up to the 6th unit of output, MC < MR & additional profit can still be extracted by producing an additional unit
  • From the 8th unit of output, MC > MR & the firm has gone beyond the profit maximisation level of output
    • It is making a marginal loss on each unit produced beyond the point where MC = MR

Normal Profit, Supernormal Profit & Losses

  • When calculating costs, Economists consider both the explicit and implicit costs of production
    • Explicit costs are the costs which have to be paid e.g raw materials, wages etc.
    • Implicit costs are the opportunity costs of production
      • This is the cost of the next best alternative to employing the firm's resources
      • E.g. if an investor puts £1m into producing bicycles & they could have put it in the bank to receive 5% interest, then the 5% represents an implicit cost
    • Implicit costs must be considered as entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere
  • Profit = total revenue (TR) - total costs (TC)
    • Total costs include explicit and implicit costs
  • Normal profit occurs when TR = TC
    • This is also called breakeven
  • Supernormal profit occurs when TR > TC
  • A loss occurs when TR < TC

Calculations To Demonstrate Profits

Output TR (£) TC (£)  Profit (TR - TC)
5 150 70 80
6 180 96 84
7 220 220 0
8 250 270 -20

 

Observations

  • Supernormal profit occurs up to the 6th unit of output
  • Normal profits occur at the 7th unit
  • From the 8th unit, the firm is making a loss

Short-run & Long-run Shut-down Points

  • Firms do not always make a profit & may endure losses for a period
    • Entrepreneurs often keep firms going in the hope that market conditions will change & demand for their products will increase leading to profitability
    • This raises the question, 'when is it the best time for a firm to shut down?'
  • The shut-down rule provides the answer by considering both the long-run & short-run periods

The Short-run Shut Down Point

  • In the short-run, if the selling price (average revenue) 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)

3-3-4-short-run-shut-down-point_edexcel-al-economics
A firm should shut down in the short-run if the selling price (AR) is unable to cover the AVC

Diagram analysis

  • The firm produces at the profit maximisation level of output (Q) where MC=MR
  • At this level, the P = AVC
    • This means that there is no contribution towards the firm's fixed costs
      • The selling price literally only covers the cost of the raw materials used in production
      • There is no point in continuing production & the firm should shut down

The Long-run Shut Down Point

  • In the long-run, if the selling price (AR) is higher than the average cost (AC) the firm should remain open (AR > AC)
    • if the selling price (AR) is equal to or lower than the average cost (AC), the firm should shut down (AR = AC)

3-3-4-long-run-shut-down-point_edexcel-al-economics

A firm should shut down in the long-run if the selling price (AR) is unable to cover the AC

Diagram analysis

  • The firm produces at the profit maximisation level of output (Q) where MC=MR
  • At this level, P < AC
    • It could continue operating in the short-run as the AR > AVC, but in the long-run they are making a loss & the firm will shut down

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