Chapter 7 - Profits,Entry,Exit, Invisible Hand

Chapter 7 - Profits,Entry,Exit, Invisible Hand - Profits...

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Profits, Entry, Exit: Basis for the ´invisible Hand´- Principles of Economics 25/11/10 Businesses move to industries and locations in which profit opportunities prosper and leave those where prospects diminish . Profit: Accounting profit: the difference between a firms revenue and its explicit costs o Explicit costs: actual payment for factors of production and other suppliers Accounting Profit = Total Revenue – Explicit Costs Economic profit: the difference between the firms revenue, its explicit and implicit costs o Implicit costs: the opportunity costs of the resources supplied by the firms owner (private or public) Economic Profit = Total Revenue – Explicit Costs – Implicit Costs o Economic loss: economic profit that is less than zero Normal Profit: the opportunity costs supplied by the firms owner Normal Profit = Accounting Profit – Economic Profit o In order to remain in business in the long run a firm needs an economic profit that is greater or equal to zero Regardless of accounting profit as resources can be supplied somewhere else with lower opportunity costs! The invisible hand theory (everything in accordance with Perfect Competition): Adam Smith’s theory of the ´invisible hand´ means that the selfish interests of buyers and sellers will result in the most efficient allocation of resources . Two functions of price: in the free-enterprise (market) system the market price serves two important and distinct functions o Rationing Function of price: is to distribute scarce goods among potential buyers to those value them the most o Allocative Function of price: to direct resources from overcrowded markets to those which are underserved markets o Requiring fully reflective supply and demand curves, underlying costs and benefits to society Responses to profits and losses: o Economic profit tend to attract additional resources Lower opportunity costs in one market will cause that others want to enter , which would result in a shift of the supply curve to the right and a fall of the equilibrium price o Economic loss tend to lose resources Higher opportunity cost in the market will cause that participants will leave the market, which will result in a
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