outline_ch07

outline_ch07 - Chapter 7: The Quest for Profit and The...

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Chapter 7: The Quest for Profit and The Invisible Hand
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I. The Central Role of Economic Profit
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Adam Smith Self-interest implies capitalists exploit Adam Smith’s essential idea – now over 200 years old, but still a crucial insight: Entrepreneur “intends only his own gain,” yet as if “led by an invisible hand to promote an end which was no part of his intentions” “Invisible Hand” = “end which was no part of his intentions” =
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Profit depends on the relationship between costs and But there are more than one type of Therefore more than one type of
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Two Types of Costs Explicit Costs Actual (Direct) payments made to factors of Implicit Costs the Opportunity (Indirect) Costs of all the resources supplied by the firm’s owners: Cost of Cost of Cost of
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Three Types of Profits Accounting Profit Total Revenue – Explicit Costs Economic Profit Total Revenue – (Explicit Costs + Implicit Costs) When profit is negative then it is called an Normal Profit Accounting Profit – Economic Profit = The = Opportunity Cost of Resources Supplied by
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Fig. 7.1 Total revenue Explicit costs Accounting Profit Explicit costs Normal profit Economic profit = = = + Normal profit Economic profit
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Example: To Farm or Not To Farm? Bernard Buffet sells wheat – suppose: his revenues are $22,000/yr he pays $10,000/yr in explicit costs he could earn $11,000 at another job he likes equally well (implicit costs – i.e. the opportunity cost of his time)
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Example: To Farm or Not To Farm? Bernard’s Accounting Profit is $22,000 - $10,000 = $ Bernard’s Economic Profit is $22,000 - $10,000 - $11,000 = $ Bernard’s Normal Profit is $ Equal to Accounting Profit - Economic Profit
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Market Forces and Economic Profit: 3 Cases Positive Economic Profit Firms will enter this Supply Price Profits
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Market Forces and Economic Profit: 3 Cases Negative Economic Profit Firms will exit this Supply Price Losses
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outline_ch07 - Chapter 7: The Quest for Profit and The...

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