Home Farm Is One of Many Small Firms Producing Lettuces and Attempting to Maximise Profits. Explain the Circumstances in Which Home Farm Might Make Supernormal Profits in the Short Run, but Only Normal Profits in the Long Run. (15 Marks)

Topics: Economics, Microeconomics, Perfect competition Pages: 2 (550 words) Published: October 31, 2012
Home Farm is one of many small firms producing lettuces and attempting to maximise profits. Explain the circumstances in which Home Farm might make supernormal profits in the short run, but only normal profits in the long run. (15 Marks) Supernormal profit is defined as extra profit above that level of normal profit.  Supernormal profit occurs where Average Revenue>Average Total Cost (AR>ATC). Supernormal profit is also known as abnormal profit. Abnormal profit means there is an incentive for other firms to enter the industry. On the other hand normal profit is defined as the minimum level of profit necessary to keep a firm in that line of business. This level of normal profit enables the firm to pay a reasonable salary to its workers and managers. The definition of normal profit occurs when Average Revenue=Average Total Cost (AR=ATC). Home farm is part of a competitive market where many firms compete fiercely with each other and have no real control over the price in the market. Therefore the assumption of perfect competition can be made. I have made this assumption due to the fact that there are a large number of buyers and sellers each with an insignificant share of the market which results in each firm becoming a price taker due to they are to small to affect the price level. Furthermore I would assume buyers and sellers have perfect information and all products are homogenous. Consequently there are no barriers to entry and exit of firms in the long run also there are no externalities and equal access to resources and knowledge for firms. Secondly I will also assume that the basic object of Home Farm is to maximise profits. Profits will be maximised where the difference between total revenue and total cost is at its greatest shown in the diagram below at the level of output where Marginal Cost (MC) = Marginal Revenue (MR).

This is known as the equilibrium position because firms have no incentive to change. At this output Home Farm...
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