Classical People & main points
WHAT DRIVES BUSINESS DECISIONS AND THE DYNAMICS OF A CAPITALIST MARKET ECONOMY?
THE PURSUIT OF ECONOMIC PROFIT
The return on these assets is the ____ of investing in/owning a business.
Opportunity Cost
Accounting Profit - opportunity cost = ?
Economic Profit
With free-entry and exit, equilibrium in the market requires
zero economic profits
The “invisible hand” of the marketplace in action is a
long-run phenomenon, not a short-run.
Who is Adam Smith?
“invisible hand”
Scottish professor of “Moral Philosophy”
Author of The Wealth of Nations (1776)
Classic Economist
Accounting Profit = ?
Explicit Costs = ?
Accounting Profit = Total Revenue - Explicit Costs
Explicit Costs = (1) labor and (2) raw material
Explicit b/c are the actual payments accounted
for during production
Inputs” in economic models are always
a.
b.
c.
a. labor
b. capital,
c. total cost is always the cost of both
Markets in which firms are earning economic profit will
attract resources
“Economic” profit means
profit in excess of a “normal” rate of return on assets
Who is David Ricardo?
English financier (mostly public debt) and economic writer.
Author of On the Principles of Political Economy and Taxation (1817)
Suppose Ingredion had total revenues of $5 million dollars from its North Kansas City plant and explicit cost (labor, raw material) of $4,000,000. What is the Accounting Profit?
AP = $5 m − $4 m = $1m
Why are Investors are attracted to firms and industries that return economic profit
Firms that earn positive economic profit earn more than their opportunity cost (next best alternative)
Markets in which firms are suffering economic losses will
lose resources
“Normal” rate of return means
the rate of return on a financial asset like a U.S. government bond.
Who is Karl Marx?
German revolutionary, journalist, and economist.
Journalist for New-York Daily Tribune (1852 - 1862)
Author of Capital (three volumes, 1867 - 1894)
Economic Profit = ?
What is implicit cost?
Implicit cost = ?
Economic Profit = Accounting Profit - Implicit Cost
Implicit cost = opportunity cost of the resources supplied by the firm’s owners
opportunity cost = earnings if they had put these resources into another use
What makes something short-run
There is fixed capital
(fixed variable)
What happens when the equilibrium price in a market results in positive economic profits
1. Markets with positive economic profit will attract new entrants
2. New entrants increase the market supply.
3. Increasing supply reduces market price
4. Reducing the market price reduces the economic profit
5. New firms continue to enter the market until economic profit is driven to zero
In the short run is the time period where a firm’s capital stock is....
is fixed
The next best alternative to investing in a business is to deposit money in a
bank or buy a government bond or other financial asset.
Suppose Ingredion could sell their facility for $10 million. The return on a U.S. government bond is about 5% per year. The opportunity cost of keeping that facility is
Opportunity Cost = $10m x .05 = $500,000
What is the response to economic loss
Firms exiting the market shifts the supply curve to the left. Market price increases. This reduces economic
losses. This will continue until the economic losses are eliminated
With free-entry and exit, the long-run equilibrium in the market is
zero economic profits
With free entry and free exit, the long-run equilibrium has
lowest prices and zero economic profit.