Profit – Normal, Supernormal and Losses

Courses Info

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes

Profit is the difference between revenue and costs; it is the reward for risk-taking

This occurs when MR = MC and is when a firm cannot raise its profit any more irrespective of increasing / decreasing the price or output

Marginal Profit – the additional profit gained from producing one extra unit
If MR > MC, the marginal profit will be positive as the revenue gained from producing on extra unit is greater than the cost of that when the firm is producing at a lower output of MR = MC
If MR < MC, the marginal profit will be negative as the cost of producing an extra unit is greater than the additional revenue gained when the firm is producing at a higher output of MR = MC

The minimum amount of profit needed for a firm to operate successfully

Where a firm makes a sufficient amount of revenue to cover its total costs and remain competitive in the market
Represents the cost of use of the entrepreneurship factor of production
Normal Profit occurs when AC = AR or TC = TR , which can also be known as the ‘break-even point’ in a perfectly competitive market
When firms make Normal Profit, the economic profit is zero

[diagram]

When firms make a profit above the level of Normal Profit

Supernormal Profit is usually made by monopolies as they have the price making power to charge higher prices at a restricted level of output
There are barriers to entry and price > average costs
The sunk costs also deter other firms from entering the market, allowing monopolies to continue to charge higher prices and make a supernormal profit

[diagram]

A firm makes a loss when its TC > TR or the average cost of production is greater than the price per unit

[diagram]

AQA Spec – Additional Content

Acts as a reward – profit is the reward that entrepreneurs gain from risk taking and making investments
Innovation – since firms want to gain profit, it encourages them to innovate more so that they can reduce their production costs and offer better quality products to consumers
Source of finance – retained profits can be a source of finance for firms if they want to make an investment and helps them to avoid costs of borrowing / interest payments
Profit can act as a signal – for e.g. in markets where firms are making high supernormal profits, other firms may view this as attractive and want to enter the market for similar reasons. Hence, market supply will increase and market price will fall

Quick Fire Quiz – Knowledge Check

1. Define ‘Profit’ (2 marks)

2. Identify the point at which firms profit maximise (2 marks)

3. Define ‘Marginal Profit’ (2 marks)

4. Explain what happens when a firm produces at MR > MC (4 marks)

5. Explain what happens when a firm produces at MR < MC (4 marks)

6. Define ‘Normal Profit’ (2 marks)

7. Using a diagram, explain what situations a firm will produce normal profit (6 marks)

8. Identify the ‘break-even point’ (2 marks)

9. Define ‘Supernormal profit’ (2 marks)

10. Using a diagram, explain what situations a firm will produce a supernormal profit (6 marks)

11. Using a diagram, explain what situations a firm will produce a loss (4 marks)

12. Explain the effect of having fewer firms operating in a market (4 marks)

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