week3_ch040.pptVIP

Chapter 4 Allocation and the Market System Organising Production How should resources be allocated among specific industries? Which specific firms should do the producing in each industry? What combination of resources- what technology- should each firm employ? Operation of the Market System What is to be produced? Determined by competing buyers and sellers in both resource and product markets Types and Quantities of Goods Produced Determined by the motives of firms to seek profits and avoid losses Firms will produce those goods and services that result in a profit Profits (or Losses) Determined by: Total revenue received by the firm from the sale of a product; and Total costs of producing that product Economic Costs and Profits Economic costs: Payments made to obtain and retain the services of a resource, including land, labour, capital and entrepreneurial ability Normal profits: the minimum cost payment that is just sufficient to obtain and retain contribution by the entrepreneur Economic Profit The total revenue of a firm less all its economic costs (including the cost of entrepreneurial ability) Also known as pure profit (or economic profit) Normal profit means zero economic profit. Economic Costs = $1300 Land – Rent - $300 Labour – Wages- $200 Capital – Interest - $400 Entrepreneur ( enough to survive- normal profit) $400 If the normal profit is $200 firm exits from the industry Economic Profit (or pure profit) Total receipts from the sales = $1500 Economic profit = TR- economic costs = $200 More firms enter Profits and Expanding Industries Economic profits induce new firms to enter the industry, resulting in an expanding industry Entry of new firms increases the market supply of the product, resulting in lower prices until normal profits are restored Losses and Declining Industries Below-normal profit induces firms to leave the industry, resulting in a declining industry As firms exit, supply decreases, and prices increase until normal profits are restor