The Normal Profit and Break-even Point
Categories: Freshers Study Economics Intermediate class NCERT
The Normal Profit and Break-even Point
The Shut Down Point
Previously, while deriving the supply curve, we have discussed that in the short run the firm continues to produce as long as the price remains greater than or equal to the minimum of AVC. Therefore, along the supply curve as we move down, the last price-output combination at which the firm produces positive output is the point of minimum AVC where the SMC curve cuts the AVC curve. Below this, there will be no production. This point is called the short run shut down point of the firm. In the long run, however, the shut down point is the minimum of LRAC curve.
The Normal Profit And Break-Even Point
The minimum level of profit that is needed to keep a firm in the existing business is defined as normal profit. A firm that does not make normal profits is not going to continue in business. Normal profits are therefore a part of the firm’s total costs. It may be useful to think of them as an opportunity cost for entrepreneurship. Profit that a firm earns over and above the normal profit is called the super-normal profit. In the long run, a firm does not produce if it earns anything less than the normal profit. In the short run, however, it may produce even if the profit is less than this level. The point on the supply curve at which a firm earns only normal profit is called the break-even point of the firm. The point of minimum average cost at which the supply curve cuts the LRAC curve (in short run, SAC curve) is therefore the break-even point of a firm.
Opportunity Cost
In economics, one often encounters the concept of opportunity cost. Opportunity cost of some activity is the gain foregone from the second best activity. Suppose you have Rs 1,000 which you decide to invest in your family business. What is the opportunity cost of your action? If you do not invest this money, you can either keep it in the house-safe which will give you zero return or you can deposit it in either bank-1 or bank-2 in which case you get an interest at the rate of 10 per cent or 5 per cent respectively. So the maximum benefit that you may get from other alternative activities is the interest from the bank-1. But this opportunity will no longer be there once you invest the money in your family business. The opportunity cost of investing the money in your family business is therefore the amount of forgone interest from the bank-1.
Determinants Of A Firm’s Supply Curve
In the previous section, we have seen that a firm’s supply curve is a part of its marginal cost curve. Thus, any factor that affects a firm’s marginal cost curve is of course a determinant of its supply curve. In this section, we discuss two such factors.
Technological Progress
Suppose a firm uses two factors of production – say, capital and labour – to produce a certain good. Subsequent to an organisational innovation by the firm, the same levels of capital and labour now produce more units of output. Put differently, to produce a given level of output, the organisational innovation allows the firm to use fewer units of inputs. It is expected that this will lower the firm’s
marginal cost at any level of output; that is, there is a rightward (or downward) shift of the MC curve. As the firm’s supply curve is essentially a segment of the MC curve, technological progress shifts the supply curve of the firm to the right. At any given market price, the firm now supplies more units of output.
Input Prices
A change in input prices also affects a firm’s supply curve. If the price of an input (say, the wage rate of labour) increases, the cost of production rises. The consequent increase in the firm’s average cost at any level of output is usually accompanied by an increase in the firm’s marginal cost at any level of output; that is, there is a leftward (or upward) shift of the MC curve. This means that the firm’s supply curve shifts to the left: at any given market price, the firm now supplies fewer units of output.