Normal Profits, Supernormal Profits and Losses

Specification Coverage: Edexcel unit 3.3.4 - Normal Profits, Supernormal Profits and Losses. Students should be able to define normal profit, supernormal profit, and loss in economic terms, apply the profit maximisation rule, analyse firm diagrams, and explain both the short-run and long-run shut-down rules.

Key Definitions

Normal profit: The minimum profit required to keep a firm in the industry, so \( TR = TC \). Also known as the break-even point.

Supernormal profit: Any profit above normal profit, so \( TR > TC \).

Loss: When \( TR < TC \).

Normal profit is a cost, not a bonus. It is the opportunity cost of the entrepreneur staying in this industry, so it is already counted inside the firm's costs. On a diagram that means a firm making normal profit sits where AR = AC, and only the area above AC is supernormal profit. Such a firm is breaking even in economic terms even though its accounts would show a positive figure.

Profit Maximisation Rule

Firms maximise profit by producing where \( MC = MR \).

Diagrammatic Representation of Profits and Losses

Firm diagram showing supernormal profit as the shaded area where average revenue exceeds average cost
Figure 1: A firm making supernormal profit, where AR (price) is above AC at the profit-maximising output Qpm. The shaded area represents supernormal profit.
Firm diagram showing a loss as the shaded area where average cost exceeds average revenue at the chosen output
Figure 2: A firm making a loss, where AR (price) is below AC at the profit-maximising output Qpm. The shaded area represents the loss.

The Shut-Down Rules

Short-Run Shut-Down Rule

In the short run, fixed costs must still be paid even if output is zero, so the firm compares price (AR) with average variable cost (AVC).

  • If \( AR > AVC \): Keep producing. Revenue covers all variable costs and makes a contribution towards fixed costs, so the loss is less than total fixed costs.
  • If \( AR < AVC \): Shut down immediately. Revenue does not even cover variable costs, so the loss is greater than total fixed costs.
Firm diagram showing price below average variable cost, the point at which a firm should shut down in the short run
Figure 3: Short-run shut-down condition. The firm should shut down if the price (AR) falls below the minimum point of AVC, as shown in the diagram. At this point, the firm cannot cover its variable costs, leading to greater losses than if it were to shut down and only incur fixed costs.

Long-Run Shut-Down Rule

In the long run, all costs are variable, so a firm can leave the industry completely.

The firm compares price (AR) with average cost (AC).

  • If \( AR > AC \), the firm is making a supernormal profit and should continue producing in the long run.
  • If \( AR < AC \), the firm is making a loss and should exit the industry in the long run.

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Ten original multiple-choice questions on normal and supernormal profit, economic against accounting profit, and the short-run and long-run shut-down rules.

Practice Questions: 3.3.4 Profits and Losses

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Six questions on Normal Profits, Supernormal Profits and Losses from the Edexcel A-Level papers, 2017–2024, 12 to 25 marks. Each one links straight to the page of the official mark scheme where its answer begins.

Past Paper Questions: 3.3.4 Profits and Losses