This chapter introduces you to the concepts of economic, accounting and normal profits. It also looks at why perfectly competitive markets are efficient, and why easy entry to and exit from markets is important in perfect competition. | The Quest for Profit and The Invisible Hand Slide 8 - What is Chapter 8 about? Slide 8 - I. The Central Role of Economic Profit Slide 8 - Adam Smith Self-interest implies capitalists exploit profit opportunities Entrepreneur “intends only his own gain,” yet he is “led by an invisible hand to promote an end which was no part of his intentions” “Invisible Hand” = market competition Slide 8 - Profits & Costs Explicit Costs Actual payments made to factors of production (labour & capital) and other input suppliers Implicit Costs the opportunity costs of all the resources supplied by the firm’s owners Opportunity cost of time supplied by owner Opportunity cost of capital supplied by owner Opportunity cost of inputs supplied by owner Slide 8 - Three Types of Profit Accounting Profit Total Revenue – Explicit Costs Economic Profit (Excess Profit) Total Revenue – (Explicit Costs + Implicit Costs) Can be called ‘excess’ because it exceeds returns necessary to attract . | The Quest for Profit and The Invisible Hand Slide 8 - What is Chapter 8 about? Slide 8 - I. The Central Role of Economic Profit Slide 8 - Adam Smith Self-interest implies capitalists exploit profit opportunities Entrepreneur “intends only his own gain,” yet he is “led by an invisible hand to promote an end which was no part of his intentions” “Invisible Hand” = market competition Slide 8 - Profits & Costs Explicit Costs Actual payments made to factors of production (labour & capital) and other input suppliers Implicit Costs the opportunity costs of all the resources supplied by the firm’s owners Opportunity cost of time supplied by owner Opportunity cost of capital supplied by owner Opportunity cost of inputs supplied by owner Slide 8 - Three Types of Profit Accounting Profit Total Revenue – Explicit Costs Economic Profit (Excess Profit) Total Revenue – (Explicit Costs + Implicit Costs) Can be called ‘excess’ because it exceeds returns necessary to attract investment & inputs of owner Normal Profit The opportunity cost of resources used in the firm (its implicit costs) Slide 8 - Figure The Difference Between Accounting Profit and Economic Profit Slide 8 - To Farm or Not To Farm? Bernard Buffet sells wheat – suppose: his revenues are $22,000/yr he pays $10,000/yr in explicit costs he could earn $11,000 at another job he likes equally well (implicit costs) Bernard’s accounting profit is $22,000 - $10,000 = $12,000 Bernard’s economic profit is $22,000 - $10,000 - $11,000 = $1,000 Bernard’s normal profit is $11,000 Equal to accounting-economic profit Slide 8 - Market Forces and Economic Profit Positive Economic Profit. Can make money over implicit costs. Firms enter the industry Supply increases. Price falls. Profits fall Negative Economic Profit. Cannot cover implicit costs. Firms exit the industry Supply decreases. Price rises. Losses fall Zero economic profit: Tendency of competitive markets Slide 8 - Fig. The Firm, the .
