3.3.4 Normal profits, supernormal profits and losses

• When does profit maximisation occur?

  It occurs when a firm or producer selects the level of output where its economic profit is the highest
• How is economic profit calculated?

  Economic profit is calculated as total revenue minus total cost (including both explicit and implicit costs)
• What is the condition for profit maximisation in the short run?

  -MR = MC

  -The firm should continue producing as long as the additional revenue generated from selling one more unit of output is greater than or equal to the additional cost of producing that unit
• What is the condition for profit maximisation in the long run?

  -P = MR = MC

  -This ensures not only profit maximization but also that firms do not enter or exit the industry in the long run
• Normal profit

  Its the minimum level of profit required to keep a firm in the industry

  
  

  Its covers all explicit and implicit costs of production but provides no extra income above those costs

  
  

  TR=TC (including the opportunity cost of the resource used)
• Supernormal profit

  It occurs when a firm's total revenue (TR) exceeds its total cost (TC), including both explicit and implicit costs

  
  

  The firm is earning more than enough to cover all costs, including the opportunity cost of the resources used

  
  

  This situation is generally temporary, as it attracts competition, which can drive down prices and reduce economic profit over time.
• Losses

  It occurs when a firm's total cost (TC) exceeds its total revenue (TR)

  
  

  The firm is not covering all of its costs, including explicit and implicit costs

  
  

  Losses can lead to a firm shutting down in the short run if it cannot cover its variable costs.
• Short-run shutdown point

  A firm should shut down in the short run if it cannot cover its variable costs

  
  

  If the total revenue (TR) is less than the variable costs (VC), the firm should shut down

  
  

  Even if the firm continues to produce and cover some of its fixed costs, it would be better off shutting down and minimising its losses equal to the fixed costs
• Long-run shutdown point:

  Firms should exit the industry if they cannot cover their total costs, including both fixed and variable costs

  
  

  In a perfectly competitive market, firms enter or exit until economic profit is driven to zero

  
  

  The long-run shutdown point is where TR=TC including both fixed and variable costs

  
  

  If TR < TC in the long run, the firm should exit the industry