L11 Econ 1011 Chapter Notes - Chapter 7: Invisible Hand, Economic Equilibrium, Opportunity Cost
16 May 2018
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Chapter 7 Efficiency, Exchange, And the Invisible Hand in Action
The Central Role of Economic Profit
ā¢ 3 types of profit
o accounting profit ā the difference between a firmās total revenue and its explicit
costs
= Total revenue ā Explicit costs
o economic profit (excess profit) ā the difference between a firmās total revenue
and the sum of its explicit and implicit costs
= Total revenue ā Explicit costs ā Implicit Costs
= Accounting Profit ā Normal Profit
o normal profit ā the opportunity cost of the resources supplied by a firmās owners
(implicit costs), equal to accounting profit minus economic profit
= Accounting Profit ā Economic Profit
ā¢ Ex: TR = $400,000, Explicit costs = $250,000, capital equipment with a total resale value
= $1 million
o Accounting profit = $400,000 ā $250,000 = $150,000
o Economic profit = $400,000 ā $250,000 ā $100,000 = $50,000/year
āŖ $100,000 = the interest the company would have made if they invested the
$1 million into a savings account
ā¢ explicit costs ā the actual payments a firm makes to its factors of production and other
suppliers
ā¢ implicit costs ā the opportunity costs of the resources supplied by the firmās owners
ā¢ economic loss ā an economic profit that is less than zero
The Invisible Hand Theory
ā¢ 2 functions of price
o rationing function of price ā changes in prices distribute scarce goods to those
consumers who value them most highly
āŖ an item in an auction will leave with the person who bids the most for it
o allocative function of price ā changes in prices direct resources away from
overcrowded markets and toward that are undeserved
āŖ resources leave markers in which price cannot cover the cost of production
and enter those in which price exceeds the cost of production
ā¢ Theory of the invisible hand ā Adam Smithās theory that the actions of independent,
self-interested buyers and sellers will often result in the most efficient allocation of
resources
ā¢ The existence of positive economic profit in a market means that producers in that market
are earning more than their OC of producing
o If price exceeds the OC of the resources required to enter the market, others will
want to enter
o With the new entry, supply shifts right and the equilibrium price falls, as does
economic profit
o Entry will continue until price falls all the way to the minimum value of ATC
(where price = ATC) ā 0 economic profit
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Document Summary
Chapter 7 efficiency, exchange, and the invisible hand in action. The central role of economic profit: 3 types of profit, accounting profit the difference between a firm"s total revenue and its explicit costs. = total revenue explicit costs: economic profit (excess profit) the difference between a firm"s total revenue and the sum of its explicit and implicit costs. = total revenue explicit costs implicit costs. = accounting profit normal profit: normal profit the opportunity cost of the resources supplied by a firm"s owners (implicit costs), equal to accounting profit minus economic profit. = accounting profit economic profit: ex: tr = ,000, explicit costs = ,000, capital equipment with a total resale value. million into a savings account suppliers implicit costs the opportunity costs of the resources supplied by the firm"s owners: economic loss an economic profit that is less than zero.
