Chapter 7 - Economics 101 Hand Chapter 7: The Quest for...

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Economics 101 Chapter 7: The Quest for Profit and the Invisible Hand 1. The Central Role of Economic Profit -Adam Smith - Self-interest implies capitalists exploit profit opportunities -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 = market competition -End which was no part of his intentions = economic efficiency -Profit and Costs -Profit depends on the relation between costs and revenues -But there are more than one type of costs -Therefore, more than one type of profit -Two Types of Costs -Explicit Costs -Actual payments made to factors of production and other suppliers -Implicit Costs -All the opportunity costs of the resources supplied by the firm’s owners -Three Types of Profit -Accounting Profit - = - Total Revenue Explicit Costs -Economic Profit - = - - Total Revenue Explicit Costs Implicit Costs -Negative Economic Profit is also called an Economic Loss -Normal Profit -The difference between accounting profit d economic profit – i.e. the income earned by the firm’s owners for time spent and for the use of capital invested -Market Forces and Economic Profit -If there is Positive Economic Profit, then : -Firms enter this industry -Supply increases -Price falls -Profits fall -If there is Negative Economic Profit, then : -Firms exit this industry -Supply decreases -Prices rise -Losses fall -Competitive Markets tend to drive Economic Profit to zero 2. How Competition Affects the Size of Firms -Long-Run Average Costs and Perfectly Competitive Markets -Long Run Average Costs (LRAC) -In the long run, firms can change their capital stock and thereby, choose their size of operations -Each size of firm has its own Average Total Cost Curve -LRAC is the minimum (envelope) of all these Average Total Cost Curves -Long-Run Equilibrium -Price is equal to minimum of LRAC -If P is lower, firms are having losses and will leave the industry -All Firms Operate at the Size that Minimizes LRAC -Long-Run Market Supply -Case 1: Cost of Additional Input is Constant
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This note was uploaded on 01/08/2009 for the course ECON 101 taught by Professor Lemche during the Summer '05 term at The University of British Columbia.

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Chapter 7 - Economics 101 Hand Chapter 7: The Quest for...

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