Model operation

It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. In this assumption, there are four categories in which companies profit will be considered:

* A firm is said to be making an economic profit when its average total cost is lower than each additional product at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and price.
* A firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profit-maximizing output.
* If the price is between the average total cost and average variable cost at the profit-maximizing output, then the company is in a state of minimal losses. The firm should still continue to produce, because the loss would be larger if it stopped production. By continuing production, the company can offset its variable costs and fixed costs eventually, but by stopping completely it would lose all its fixed costs.
* If the price is below average variable cost at maximizing profits, companies should go into shutdown. Losses are minimized by not producing at all, because production would not generate significant benefits to cover all fixed costs and part of the cost variable. By not producing, the firm loses only its fixed cost. With the loss of fixed cost the company faces a challenge. Will exit the market completely or remain competitive with the overall risk of loss.