Perfect Competition: Profit, Loss, and Shutdown Analysis
Perfect Competition
1) Super Normal Profit
A perfectly competitive firm is in equilibrium at point E, where MR = MC and MC cuts MR from below. OQE is the equilibrium output. OP is the equilibrium price, which is equal to EQE, and CQE is the average cost. As price is greater than average cost, the firm is earning Super Normal Profit (SNP), which is equal to the rectangular area PBCE.
2) Normal Profit
Normal Profit (NP) is the minimum amount of profit a producer must earn to stay in the same business. It is equal to the opportunity cost of being in the business.
OQE is equal to the equilibrium price, and EQE is the average cost. As price is equal to average cost, the firm is earning NP or zero economic profit.
3) Loss Minimizing Case
OQE = equilibrium output. OPE = EQE. CQE = average cost.
As price is less than average cost, the firm is facing a loss equal to the rectangular area PBCE. In order to decide whether the firm should continue or shut down its business, the producer will compare total fixed cost with the amount of loss. If total fixed cost is greater than the loss, the firm will continue its operations.
4) Shutdown Case
OQE = equilibrium, OP = EQE (Equilibrium price), CQE is average cost.
As price is less than average cost, the firm faces a loss equal to the rectangle PBCE.
In order to decide whether the firm should continue or shut down its business, the producer will compare total fixed cost with the amount of loss. As total fixed cost is equal to the area of loss PBCE, the firm will shut down its business.
Perfect Competition
1) Super Normal Profit
A perfectly competitive firm is in equilibrium at point E, where MR = MC and MC cuts MR from below. OQE is the equilibrium output. OP is the equilibrium price, which is equal to EQE, and CQE is the average cost. As price is greater than average cost, the firm is earning Super Normal Profit (SNP), which is equal to the rectangular area PBCE.
2) Normal Profit
Normal Profit (NP) is the minimum amount of profit a producer must earn to stay in the same business. It is equal to the opportunity cost of being in the business.
OQE is equal to the equilibrium price, and EQE is the average cost. As price is equal to average cost, the firm is earning NP or zero economic profit.
3) Loss Minimizing Case
OQE = equilibrium output. OPE = EQE. CQE = average cost.
As price is less than average cost, the firm is facing a loss equal to the rectangular area PBCE. In order to decide whether the firm should continue or shut down its business, the producer will compare total fixed cost with the amount of loss. If total fixed cost is greater than the loss, the firm will continue its operations.
4) Shutdown Case
OQE = equilibrium, OP = EQE (Equilibrium price), CQE is average cost.
As price is less than average cost, the firm faces a loss equal to the rectangle PBCE.
In order to decide whether the firm should continue or shut down its business, the producer will compare total fixed cost with the amount of loss. As total fixed cost is equal to the area of loss PBCE, the firm will shut down its business.