Chap_08 - Chapter 8 The Quest for Profit and The Invisible...

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Chapter 8 The Quest for Profit and The Invisible Hand Purpose: This chapter relates the lessons of earlier chapters to the real world of firms, resources, profits, and losses. It uses theoretical concepts and definitions to explain different definitions of profits. It uses demand and supply curves and the cost curves of a firm to reveal and explain the rationing and the allocative functions of the market. It shows how profits turn into rents and can then become capitalized into the value of the assets used to produce them. Length: 25 pages Time required to read: One and one-half to two hours. After a very difficult opening section, the chapter becomes easier than some because it fits with the intuition of market economics and it is based on situations that are within the students’ experience. It includes themes that expand and refine reasoning that most students bring to the class. Number of lectures required for class understanding: At least two. The three definitions of profit plus the notion of economic rent will take more time than most definitions. The discussion of capitalization and calculating present values will also take time. The general message of the chapter flows quite well and is understandable to most students. Summary The chapter opens with an easy-to-understand glimpse at the restaurant scene in Ithaca, New York. The emphasis is on the frequency with which these businesses change owners and managers. The changes come as a result of changes in profitability. This leads to a quote from Adam Smith and a brief comment on how his 1776 writings are applicable today.
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Economic profit is differentiated from accounting profit; normal profit is explained as the opportunity cost of using resources in a certain way. Adam Smith’s invisible hand helps explain how market prices in a market economy become the force that rations finished goods among eager consumers and the force that allocates resources among potential producers. The cost curves of earlier chapters are used to help explain expansion and contraction of output as firms react to profits and losses and attempt to move toward equilibrium. Movements hinge on free entry and exit – something that has not been discussed until now. Economic rent is explained as a surplus over and above the amount needed to keep a factor in its present employment. Rent is explained as a unique kind of economic profit. Rent is a distributional issue that helps determine who receives the rewards associated with profitable operation of a firm. Examples of the invisible hand in action come from technical change, regulated markets, anti-poverty programs, and the stock market. Lessons from the stock market are extended to provide definitions and instruction on how to calculate the present values of long-term assets. The formula PV = M/ (1+r) T is explained and related to achieving efficiency in the asset market. The chapter ends with a brief discussion of the relationship between the firm and society.
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Chap_08 - Chapter 8 The Quest for Profit and The Invisible...

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