Topics: Microeconomics | Theory of the Firm | Market Structures
Level: JC H2 Economics / IB Economics HL
Mastered Supernormal Profits but get confused when drawing Subnormal Profits (Losses)? In Part 1, we learned how to draw positive economic profits. But what happens when a firm is making a loss? Knowing how to accurately shift your Average Cost curve to show Subnormal Profits is a critical skill for answering questions about Market Failure, Monopolistic Competition in the long run, and Shut-Down conditions.
Watch the tutorial above with the accompanying notes below:
1. The Profit Maximization Rule Remains the Same
Even if a firm is making a loss, it still wants to minimize that loss.
The firm will still produce at the point where Marginal Cost (MC) = Marginal Revenue (MR).
You still drop a line down to the X-axis to find your Quantity (Q), and draw a line up to the Average Revenue (AR) curve to find your Price (P).
2. Drawing the Subnormal Profit (Loss)
The only difference between Supernormal and Subnormal profit on a diagram is the position of the Average Cost (AC) curve.
To show a loss, your AC curve must be drawn above the Average Revenue (AR) curve at the profit-maximizing quantity.
Go to your Quantity (Q) and draw a line up to the AC curve. Look left to find the cost per unit.
Because your Cost per unit (AC) is higher than your Price (AR), the firm is making a loss.
3. Shading the Area
The Loss Rectangle: Shade the area bounded by the higher Average Cost (AC), the lower Price (AR), the Y-axis, and your Quantity (Q).
Confused about when a loss-making firm should shut down? We make complex Market Structure concepts incredibly easy to understand. Join our JC Economics Tuition A-Level or IB Economics Tuition classes. (For detailed explanations on the Shut-Down Condition, read our Free Notes on Firms & Decisions. For other topics, browse our full Economics Notes Library).