Normal profit, losses and shutdown
| English | 中文 | Pinyin |
|---|---|---|
| normal profit/ˈnɔːml ˈprɒfɪt/ | 正常利润 | zhèng cháng lì rùn |
| shutdown point | 停产点 | tíng chǎn diǎn |
A decision you can investigate
- A firm can make an accounting surplus yet earn only the required return on the owner’s resources. It can also minimize a short-run loss by operating while covering variable costs.
- Zero economic profit is different from no sales or no accounting return.
Build the explanation
- Economic profit is revenue minus all economic costs, including the normal return needed to keep resources in their current use. Normal profit 正常利润 means zero economic profit after that required return; supernormal profit is a positive excess and an economic loss is negative. If accounting costs exclude an owner’s opportunity cost, accounting profit and economic profit differ.
- In a short-run shutdown comparison, fixed unavoidable costs remain even if output stops, while avoidable operating costs are saved. Operating can be preferable if receipts cover avoidable variable costs and contribute to those unavoidable costs. In the standard competitive smooth model the shutdown threshold is minimum AVC; at equality the firm is indifferent under the assumptions. In the long run costs can become avoidable and sustained prices below minimum LRAC do not cover the normal return, supporting exit rather than indefinite production.
Work through the evidence
- A fictional enterprise has revenue1000, recorded cash/resource costs700 and an owner opportunity cost300. Accounting surplus300 becomes economic profit0: the stated normal return is covered. Raising revenue to1100 with these costs unchanged yields economic profit100.
- A separate constrained short-run firm can operate a batch of50 units or close. Unavoidable fixed cost100 and variable cost3 per unit give TC250 when operating. At price4, revenue200 and economic loss50; closure leaves loss100, so operation reduces the loss by50. At price2, receipts100 produce loss150, worse than closure’s100, so close under these assumptions. At price3, receipts150 cover variable cost150 and either choice loses100.
- For a separate long-run case, suppose the minimum attainable LRAC across feasible scales is5 and market price stays4: sustained operation cannot cover all economic costs; exit is indicated if the assumptions persist.
What is economic profit in the first enterprise?
Revenue1000 less recorded costs700 and opportunity cost300 equals0.
What is the operating loss at price4 in the batch case?
TC250 less receipts200 equals loss50.
A firm making a short-run economic loss must always shut down immediately.
It may cover avoidable costs and contribute to unavoidable costs, reducing the loss.
Test the limits
- For the batch case, Q50 is a stated feasible operating choice, not proof that it maximizes profit over every possible quantity. For a smooth competitive firm, first choose the best output and then compare receipts with avoidable costs. Fixed/variable classifications are not identical to sunk/avoidable classifications; contract terms, shutdown costs and time horizons matter.
- The long-run benchmark is minimum attainable cost, not any arbitrary current ATC. Temporary losses can be consistent with rational operation, while expected future returns may influence investment or exit. Market power, multi-product links, restarting costs and worker commitments can complicate the choice. Never call normal economic profit zero income for the owner: the normal return is already included in cost.
At price2, which batch decision minimizes the stated loss?
Closing avoids variable costs; only unavoidable fixed cost100 remains.
Apply and explain your answer
- Why is operating at price4 rational despite the economic loss50 in the batch case?
- It covers variable cost150 and contributes50 to unavoidable fixed cost100. Closure would lose the full100.
Match the terms to their meanings.
Use each term for its stated economic relationship.
Use the terms precisely
- normal profit: The required return included in economic cost; zero economic profit when it is just covered.
- shutdown point 停产点: The short-run threshold where operating receipts just cover avoidable operating costs under the stated model.
A fictional enterprise has revenue1000, recorded cash/resource costs700 and an owner opportunity cost300. Accounting surplus300 becomes economic profit0: the stated normal return is covered. Raising revenue to1100 with these costs unchanged yields economic profit100. A separate constrained short-run firm can operate a batch of50 units or close. Unavoidable fixed cost100 and variable cost3 per unit give TC250 when operating. At price4, revenue200 and economic loss50; closure leaves loss100, so operation reduces the loss by50. At price2, receipts100 produce loss150, worse than closure’s100, so close under these assumptions. At price3, receipts150 cover variable cost150 and either choice loses100. For a separate long-run case, suppose the minimum attainable LRAC across feasible scales is5 and market price stays4: sustained operation cannot cover all economic costs; exit is indicated if the assumptions persist.
For the batch case, Q50 is a stated feasible operating choice, not proof that it maximizes profit over every possible quantity. For a smooth competitive firm, first choose the best output and then compare receipts with avoidable costs. Fixed/variable classifications are not identical to sunk/avoidable classifications; contract terms, shutdown costs and time horizons matter. The long-run benchmark is minimum attainable cost, not any arbitrary current ATC. Temporary losses can be consistent with rational operation, while expected future returns may influence investment or exit. Market power, multi-product links, restarting costs and worker commitments can complicate the choice. Never call normal economic profit zero income for the owner: the normal return is already included in cost.
Economic profit is revenue minus all economic costs, including the normal return needed to keep resources in their current use. Normal profit means zero economic profit after that required return; supernormal profit is a positive excess and an economic loss is negative. If accounting costs exclude an owner’s opportunity cost, accounting profit and economic profit differ.