chapter8

chapter8 - 1 The Quest for Profit and the Invisible Hand...

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Unformatted text preview: 1 The Quest for Profit and the Invisible Hand According to Adam Smith People are motivated by self-interest. The goal of profit maximization will serve society’s collective interest. Slide 2 Accounting Profit = total revenue – explicit costs (payments for factors of production) Economic Profit = total revenue – explicit costs – implicit costs (opportunity cost of the resources supplied by the firm’s owners) Slide 3 Costs incur without explicit money involved E.g., use your own garage for storage Forego the opportunity to rent out your garage , the opportunity cost is the lost income from renting the garage out. Suppose a firm has the following: Total Revenue ( TR) = $400,000 Explicit costs (salaries) = $250,000/yr Machinery and other equipment with a resale value of $1 million Slide 5 Accounting Profit $400,000( TR ) - $250,000 (explicit costs) = $150,000 Slide 6 To calculate economic profits, assume Annual interest on savings = 10% [Then the $1 million spent on equipment could have earned $100,000/yr had it been invested] Economic Profit $400,000 ( TR ) - $250,000 (explicit cost) - $100,000 (implicit cost) = $50,000 Slide 7 Slide 8 Total revenue Explicit costs Accounting profit opportunity cost of resources supplied by owners of firm Economic profit Explicit costs Why are the distinctions important? Only economic profit serve the following economic functions: Rationing function Allocative function Slide 9 Should Pudge Buffet stay in the farming business? He is a corn farmer with payments for land and equipment = $10,000/yr He supplies only his labor which he values equally to managing a retail store for $11,000/yr Except for pay, he is indifferent between the farm or the store Corn sells at a constant price and TR = $22,000 Slide 10 Slide 11 Total Explicit Implicit Accounting Economic revenue costs costs profit profit ($/year) ($/year) ($/year) ($/year) ($/year) 22,000 10,000 11,000 12,000 1,000 What would Pudge’s economic profit be if TR = $20,000 Economic profit TR (20,000) – explicit (10,000) and implicit costs (11,000) = -$1,000 Question Should Pudge stay in farming?...
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This note was uploaded on 03/12/2012 for the course ECON 1002 taught by Professor Fu during the Winter '09 term at HKU.

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chapter8 - 1 The Quest for Profit and the Invisible Hand...

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