Profit

Total Profit= TR- TC Very important: TC includes fixed, variable and opportunity cost (i.e. payment to all the factors of production incl. the entrepreneur)

Profit measures the return to risk when committing scarce resources to a market or industry Entrepreneurs take risks for which they require an adequate expected rate of return The higher the market risk and the longer they expect to have to wait to earn a positive return, the greater will be the minimum required return that an entrepreneur is likely to demand

Profit eg. Firm AFirm BFirm C TR200, 000 TFC40, 000 TVC80, , , 000 Opportunity Cost60, 000 TC180, , , 000 Profit or Loss? Entrepreneur expects to earn 60, 000 that is what the entrepreneur could earn if she had stayed in her old job- i.e. that is the ‘next best alternative’) If the opportunity cost is not being covered the entrepreneur will close down the firm and move onto to the next best occupation

The shut- down price Firm DFirm EFirm F TR80, , , 000 TFC (incl OC)100, 000 TVC100, , , 000 TC200, , , 000 Loss120, , 00090, 000 Some firms continue to operate in the short- run, even if they are making a loss. Why? When will a firm shut down production in the short run? (Remember FC need to be paid regardless of output) Firm D- TR does not cover TVC. Loss 120, 000 if operates, only 100,000 if closes Firm E- TR covers TVC thus loss is 100, 000 if closes or not Firm F- TR covers TVC and contributes 10, 000 to TFC

Definition The shut- down price is the level of price that enables a firm to cover it’s variable costs in the short- run. i.e. it is the price where P= AVC. If price does not cover AVCs then the firm will shut down in the short run. Can occur with seasonal demand eg. Ice cream stalls

The Break- Even Price The price at which a firm is able to make normal profits in the long –run The break- even price is the price that enables a firm to cover all of it’s costs in the long- run i.e. P= ATC

Costs Output MC ATC Optimum Output MC= AC AVC P1= ATC P= AVC P= shut down price P1= breakeven price

Profit Maximising Level of Output Usual assumption- firms aim to maximise profit They will produce at an output level where MC=MR Wherever the firm finds that MR>MC it should increase output as profits will increase as extra units are produced

Cost/ Price (£) Output MC D= AR= MRP q1q2 At q1 the firm has made a loss on every unit of produced up to this level of output as MC>MR q1-q2 firm makes a profit on every unit produced as MR>MC q2= max profit as after this point MC>MR q1 = profit minimising, thus usually ignore that part of MC curve Price Taking Firm

Cost/ Price (£) Output MC Firm facing a downward sloping demand curve MR D= AR P q

Therefore….. Profit Maximising level of output occurs where MC= MRProfit Maximising level of output occurs where MC= MR Whether the firm makes normal, abnormal or subnormal profit depends on…. The position of the AC curve!!!

Cost/ Price Output MC AC D= AR MR P a b c Firm making Abnormal Profit OR Supernormal Profit Profit maximising at output MC=MR At this output level AC<AR= Abnormal Profit shown by rectangle Pabc

Cost/ Price (£) Output MC AC D= AR MR c1= P a Firm making Normal Profit Profit maximising at output MC=MR At this output level AC=AR= normal profit

Cost/ Price Output MC D= AR MR P a AC2 c2 d Firm making Subnormal Profit OR Loss Profit maximising at output MC=MR At this output level AC>AR= subnormal profit

Alternative Objectives of the Firm Revenue Maximisation Sales Maximisation Profit Satisficing Other Stakeholder Objectives eg. Environmental concerns To be covered later…