Bài giảng Microeconomics - Chapter 8 The Quest for Profit and The Invisible Hand

The Quest for Profit and The Invisible Hand0What is Chapter 8 about?1I. The Central Role of Economic ProfitSlide 8 - 22Adam SmithSelf-interest implies capitalists exploit profit opportunitiesEntrepreneur “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 competition3Profits & CostsExplicit CostsActual payments made to factors of production (labour & capital) and other input suppliersImplicit Coststhe opportunity costs of all the resources supplied by the firm’s ownersOpportunity cost of time supplied by ownerOpportunity cost of capital supplied by ownerOpportunity cost of inputs supplied by owner4Three Types of ProfitAccounting Profit Total Revenue – Explicit CostsEconomic Profit (Excess Profit) Total Revenue – (Explicit Costs + Implicit Costs)Can be called ‘excess’ because it exceeds returns necessary to attract investment & inputs of ownerNormal ProfitThe opportunity cost of resources used in the firm (its implicit costs)5Figure 8.1The Difference Between Accounting Profit and Economic Profit6To Farm or Not To Farm?Bernard Buffet sells wheat – suppose:his revenues are $22,000/yrhe pays $10,000/yr in explicit costshe 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 = $1,000Bernard’s normal profit is $11,000Equal to accounting-economic profit7Market Forces and Economic ProfitPositive Economic Profit. Can make money over implicit costs. Firms enter the industrySupply increases. Price falls. Profits fallNegative Economic Profit. Cannot cover implicit costs. Firms exit the industrySupply decreases. Price rises. Losses fallZero economic profit: Tendency of competitive markets8Fig. 8.2The Firm, the Market, and a Shift in the Short-Run Supply: Responses of a Wheat Farm and the Wheat MarketQuantity (1000s of bu/yr)(a)FarmPrice ($/bu)2.202.122.102.001.9002468101214Quantity (Millions bu/yr)(b)MarketPrice ($/bu)2.122.001.90024681012142.202.10D’DSRSSRS’MCATC9II. How Competition Affects the Size of FirmsSlide 8 - 1010Long-Run Average Cost and Perfectly Competitive MarketsLong-Run Average Cost (LRAC)Each size of firm has its own Average Total Cost curveLRAC is the minimum average cost for a given level of output - if the size of firm can be chosen at willLong-Run Competitive EquilibriumPrice is at the minimum of LRACIf P is higher, firms producing at minimum LRAC can make an economic profit and will enter industryAll firms operate at the size that minimizes LRAC11Fig. 8.4Long-Run Average Cost12Fig. 8.5Long-Run Equilibrium in a Perfectly Competitive Market13Long-Run Market SupplyCase I: Cost of Additional Inputs is ConstantAn increase in Price causes economic profitsNew firms enter until Price is driven back to the level where it startedLong-Run Supply (LRS) is perfectly elasticCase II: Cost of Additional Inputs RisesAn increase in Price causes economic profitsNew firms enter, driving down Price but also increasing costsPrice falls, but not to where it startedLRS is upward sloping14Fig. 8.6Long-Run Supply (LRS) in a Perfectly Competitive Market—Case I: Constant Opportunity Cost of InputsQuantity (1000s of bu/yr)(a)FarmPrice ($/bu)2.202.102.001.900246810121416Quantity (millions bu/yr)(b)MarketPrice ($/bu)2.202.102.001.900246810121416LRACSRSSRS’LRSDD’Q1Q2Q315Fig. 8.7Long-Run Supply (LRS) in a Perfectly Competitive Market—Case II: Cost of Inputs Rises as Short-Run Supply IncreasesQuantity (1000s of bu/yr)(a)FarmPrice ($/bu)2.202.142.102.001.900246810121416Quantity (millions bu/yr)(b)MarketPrice ($/bu)2.202.001.900246810121416LRAC2LRAC1SRSSRS’LRSDD’2.142.1016Firm Size and the Shape of the Long-Run Average Cost CurveIt is possible that minimum LRAC can be achieved over a wide range of outputThen different firm sizes can coexist in long-run equilibriumWe can divide the LRAC curve into 3 regionsEconomies of scale: LRAC fallingConstant returns to scale: LRAC constantDiseconomies of scale: LRAC rising17Fig. 8.8Long-Run Average Cost and Returns to Scale18III. The Invisible Hand TheorySlide 8 - 1919Invisible Hand TheoryThe actions of independent, self-interested buyers and sellers will often result in the efficient allocation of resources‘Efficient’ does not mean optimal in every way20Functions of PriceRationing function of pricePrices distribute scarce goods to those consumers who are willing and able to pay the most for them –I.e. value them the most highlyAllocative function of pricePrice signal directs resources away from overcrowded markets and toward markets that are under-served21Fig. 8.9An Imbalance in the Markets for Haircuts and Aerobics Classes22Free Entry and ExitThe Invisible Hand Theory depends critically on freedom of firms to enter and exitBarrier to entry:Anything that prevents new suppliers from entering a marketLegal (e.g., copyright laws)Natural (e.g., product compatibility)Barriers to entry allow price to be higher than the opportunity costs of production23Economic RentThat part of the payment for a factor of production that exceeds the owner’s reservation priceReservation price: The price below which the owner would not supply the factorEconomic rent accrues to inputs that cannot be replicated easilyExample: How much does Celine Dion actually make? What’s the lowest amount she would take to keep singing? Difference = Rent24Cost-Saving InnovationsFirms that develop and introduce cost-saving innovations: Reap economic profits in the short runSupply curves shift rightward as new firms enterPrices fallFirms that do not use the new technology will suffer economic lossesCompetition implies that the cost savings are passed along to consumers25IV. The Invisible Hand in ActionSlide 8 - 2626The Invisible Hand in the Stock MarketShare of stock:A claim to a share of the current and future accounting profits of a companyEarnings received in the future are not as valuable as earnings received today(Remember the time value of money - we could put today’s earnings in the bank and earn interest on them)27How much will a share of stock sell for?Assume that a company’s only accounting profit of $14,400 will be paid out in two yearsHow much is a share of this company worth?Let PV stand for present valueLet r stand for market rate of interest measured as a fraction (e.g., 10% is given as r = 0.10)28Present Value (a)The present value of $14,400 in two years is the amount we would have to put in the bank today to earn $14,400 in two years29Present Value (b)IF the market interest rate is 20% (r = .20),$14,400 two years from now is worth $10,000 today at an interest rate of 20%30Present Value Formula31V. The Distinction Between an Equilibrium and a Social OptimumSlide 8 - 3232Equilibrium When markets reach equilibrium there is no incentive for any individual to change their behavior:all opportunities for private gain exhaustedBut there may be several possible equilibria, & co-ordination may make everyone better offExample: laws to regulate weights & measures, or set cleanliness standards in restaurants33Equilibrium and Social OptimumMarket equilibrium does not mean the resulting allocation of resources is socially optimalSmart for one, dumb for all ?Market activities that produce profits for some may produce pollution for manyOnly if prices actually reflect ALL costs of a good’s production will the price signal guide producers to optimal allocation34End of Chapter SlidesConcept Maps meant for student printouts follow.Concept Map slides are also available in pdf format.Slide 8 - 3535What is Chapter 8 about?36I. The Central Role of Economic Profit37II. How Competition Affects the Size of Firms38III. The Invisible Hand Theory39IV. The Invisible Hand in Action40V. The Distinction Between an Equilibrium and a Social Optimum41Summary of Chapter 842