Economics IB HL

Theory of the Firm Graphs

1. Abnormal Profit 

ab profits final The graph above shows a firm’s abnormal profit. In a monopolistic competition, a firm can earn economic profits in the short run. At QE, MC = MR because the firm sets the price of a product at that quantity, charging PE; as much as the demand allows. At QE, the ATC is lower than PE, therefore there is economic profit. The shaded area shows the total economic profit, which is the “abnormal profit”.
2. Break-even/Shutdown Points 
breakeven:shutdown points
At the break-even point, MC = ATC. At this point, the firm is covering all its economic costs and is earning a normal profit, but not any economic profits. Below the break-even point is the shutdown point where MC = AVC. At this point, the firm earns economic losses as its total costs exceed its total revenues, and the firm must close.
3. LRAC/SRAC and Economies/Diseconomies of Scale 
lrac:srac:e scales
In the long run (LRAC) is made up of several short run costs (SRAC), where a firm decides to open new “plants” (factories/offices/shops, depending on the type of firm). For the 1st, 2nd, and 3rd plants, the firm experiences economies of scale, where the increase in input leads to a large increase in output, so it is advantageous. At the 4th plant it is at constant returns to scale, where the increase in input equals the increase in output. However, for the 5th, 6th, and 7th plants, the firm experiences diseconomies of scale, where the increase in input leads to a smaller increase or a decrease in output, so it is disadvantageous.
4. Kinked Demand Curve
kinked demand
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