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Flashcards in Foundations of Economic Analysis: Profits Deck (7)
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1

What is meant by profit maximisation?

Apple reported a net quarterly profit of $18bn ($18.4bn) in January 2016, a record for a public company.

Profit is defined as:
Profit = Total Revenue - Total Cost
or in shorthand: = TR - TC
where is economist's shorthand for Total Profit, TR is total Revenue and TC is total cost.

2

How can we find profit maximising and output?

Must look at problem in terms of marginal quantities.
MC tends to go up and MR tends to go down.

Firms try to make a profit on each additional unit of output.

However, since MC is rising and MR is falling there must be a point at which the firm stops making a profit on an additional unit of output. This is when MR = MC

If MR > MC, can still make additional profit by making one more unit of the good.

If MR < MC, the firm is making a loss on the additional unit of the good. Profit would increase in total by making fewer goods.

A firm is maximising profit at the point where MC = MR

3

What is the difference between accountancy profit and economic profit?

Accountancy profit = Sales revenue – Accounting cost

Economic profit = Sales revenue – Economic cost

Economic cost is determined by the opportunity cost, i.e. the best foregone (next best) alternative use of resources. For example:

The opportunity cost of undertaking university education must take account of the foregone earnings while at uni.

The opportunity cost of starting up your own business should also take account of what you could have earned as an employee.

4

What is meant by exit?

However it is unable to pay all of its debts so the position is unsustainable - although it can survive in the short-term by covering its wage bill.

In the longer term firms will go bankrupt or leave the market.

5

Only Monopolies can Make Super-normal Profit - explain.

Again, profit maximising when MR= MC.

The firm is making super normal profit:
Profit = (AR - AC)Q

The market is not clearing i.e. the equilibrium quantity and price are not where Qd = Qs.

Since there are barriers to entry these problems cannot be competed away.

6

An entire spectrum of market structures - what are the differences?

Perfect Competition
Many firms, each with zero market share
P = MC
Economic Profits = 0 (Firm’s earn a reasonable rate of return on invested capital

Monopoly
One firm, with 100% market share
P > MC
Economic Profits > 0 (Firm’s earn excessive rates of return on invested capital)

7

What is consumer surplus?

Consumer Surplus (CS): is defined as the difference between the consumers' willingness to pay (represented by the demand curve) for a commodity and the actual price paid by them, or the equilibrium price.

With higher CS, consumers benefit from increased competition.

Similarly we can define producer surplus as shown by the area above the supply curve and below the market price.
Total (social) surplus = Consumer Surplus + Producer Surplus