lecture 3 nature of economic profit economic relationships demand supply
DESCRIPTION
Revenue is the income earned by a firm through its normal course of business Costs – Explicit costs are the actual out of pocket expenditures of the firm to purchase/ hire the inputs it requires in production Implicit costs refer to the value of the inputs owned and used by the firm in its own production processesTRANSCRIPT
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Lecture 3
•Nature of Economic Profit•Economic Relationships•Demand & Supply
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NATURE AND FUNCTION OF PROFIT Difference between the revenues earned
from the sale of goods and services and the costs incurred in earning these revenues
Profit = Revenues – Costs
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Revenues and Costs Revenue is the income earned by a firm
through its normal course of business
Costs –Explicit costs are the actual out of
pocket expenditures of the firm to purchase/ hire the inputs it requires in production
Implicit costs refer to the value of the inputs owned and used by the firm in its own production processes
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Definitions of Profit Accounting/Business Profit: Total
revenue minus the explicit or accounting costs of production.
Economic Profit: Total revenue minus the explicit and implicit costs of production.
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Example: A recent graduate has received a scholarship of Rs 4,00,000 to study
abroad. But he decides to start his own business where he has invested his own savings of Rs 2,00,000 which were earning interest @ 5% p.a. He also used a building he owns that has been rented for Rs 20,000 per month. Revenue in the new business during first year is Rs 10,00,000 and other expenses are:
Advertisement Rs 60,000Rent Rs 1,00,000Taxes Rs 60,000Employee Salaries Rs 4,50,000Supplies Rs 40,000
Calculate the Business and Economic Profit.
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Explicit costs
Advertisement: Rs 60,000 Rent: Rs 1,00,000 Taxes: Rs 60,000 Employee Salaries Rs 4,50,000 Supplies Rs 40,000 Total Rs 7,10,000
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Implicit costs
Scholarship= Rs 4,00,000
Rs.200000 invested in business can earn interest in the bank account @ 5% per year=
Rs 10,000
Rent= 20,000 x 12=240,000
Total=650,000
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Business Profit= 2,90,000
Economic Profit= -3,60,000
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Economic Relationships
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Economic Relationships
y = f(x)
y = f(x,z,w)
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Total Product - total number of goods produced during a specified period of time using a particular input
Average product - the average output per unit of input used
AP = TP / L Marginal product - is the change in the TP
corresponding to one unit change in the input.MP = TP / L
TOTAL AVERAGE MARGINAL
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Number of Total Average Marginal Workers Product Product Product
(L) (Q) (AP) (MP)0 0 0 01 2 2.0 22 5 2.5 33 9 3.0 44 14 3.5 55 22 4.4 86 40 6.7 187 57 8.1 178 63 7.9 69 64 7.1 110 63 6.3 -1
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Number of Total Average Marginal Workers Product Product Product
(L) (Q) (AP) (MP)0 0 0 01 2 2.0 22 5 2.5 33 9 3.0 44 14 3.5 55 22 4.4 86 40 6.7 187 57 8.1 178 63 7.9 69 64 7.1 110 63 6.3 -1
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Number of Total Average Marginal Workers Product Product Product
(L) (Q) (AP) (MP)0 01 2 2.0 22 5 2.5 33 9 3.0 44 14 3.5 55 22 4.4 86 40 6.7 187 57 8.1 178 63 7.9 69 64 7.1 110 63 6.3 -1
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TOTAL PRODUCT
0
10
20
30
40
50
60
70
0 1 2 3 4 5 6 7 8 9 10 11Rate of Labor Input
Tota
l Pro
duct
AVERAGE & MARGINAL PRODUCT FUNCTIONS
-5
0
5
10
15
20
0 1 2 3 4 5 6 7 8 9 10 11Rate of Labor InputA
vera
ge &
Mar
gina
l Pro
duct
Average Product
Marginal Product
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TOTAL PRODUCT
0
10
20
30
40
50
60
70
0 1 2 3 4 5 6 7 8 9 10 11Rate of Labor Input
Tota
l Pro
duct
AVERAGE & MARGINAL PRODUCT FUNCTIONS
-5
0
5
10
15
20
0 1 2 3 4 5 6 7 8 9 10 11Rate of Labor Input
Ave
rage
& M
argi
nal P
rodu
ct
Average Product
Marginal Product
Slope = 8.1
ESlope = 4
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TOTAL PRODUCT
0
10
20
30
40
50
60
70
0 1 2 3 4 5 6 7 8 9 10 11Rate of Labor Input
Tota
l Pro
duct
AVERAGE & MARGINAL PRODUCT FUNCTIONS
-5
0
5
10
15
20
0 1 2 3 4 5 6 7 8 9 10 11Rate of Labor InputA
vera
ge &
Mar
gina
l Pro
duct
F
Average Product
Marginal Product
Slope = 8.1
ESlope = 4
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DEMAND AND SUPPLY
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BASICS OF DEMAND, SUPPLY AND EQUILIBRIUM
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DEMAND SIDE OF THE MARKET Effective Desire (Desire backed by
purchasing power) Demand for a commodity by a consumption
unit is the quantity that it is willing and able to buy in a given period of time at a given price
Determinants of Demandprice of the product level of income and wealthprices of other productstastes and preferencesexpectation of future income
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Individual Consumer’s DemandQdX = f(PX, I, PY, T)
quantity demanded of commodity X by an individual per time period
price per unit of commodity X
consumer’s income
price of related (substitute or complementary) commodity
tastes of the consumer
QdX =
PX =
I =
PY =
T =
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Demand Schedule- A table showing how much of a given product a consumption unit would be able to willingly buy at different prices
Demand Schedule for telephone calls
Price per Calls per call monthP Q0 30
0.5 253.5 77 310 115 0
DEMAND SCHEDULE
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Law of Demand A decrease in the price of a good, all other
things held constant, will cause an increase in the quantity demanded of the good.
An increase in the price of a good, all other things held constant, will cause a decrease in the quantity demanded of the good.
Assumption income, wealth, tastes and preferences,
prices of other products and future expectations are constant
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Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
An increase in price causes a decrease in quantity demanded.
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Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
A decrease in price causes an increase in quantity demanded.
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Shift in Demand is represented by a movement of the entire demand curve.
Factors affecting the demand curve: Change in Buyers’ Tastes Change in Buyers Incomes
Normal GoodsInferior Goods
Change in the Price of Related GoodsSubstitute GoodsComplementary Goods
SHIFT IN DEMAND CURVE
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Quantity
Price
P0
Q0 Q1
An increase in demand refers to a rightward shift in the market demand curve.
SHIFT IN DEMAND CURVE
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Quantity
Price
P0
A decrease in demand refers to a leftward shift in the market demand curve.
Q2 Q0
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SUPPLY SIDE OF THE MARKET Supply is the amount of product that a firm
would be willing and able to offer for sale at a particular price during a given period of time.
Determinants of supplyprice of the productcost of production
price of required inputstechnologies
prices of related products
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Supply schedule- A table showing how much of a product firms will supply at different prices
Supply Schedule for telephones in a month
Price per production unit per monthP Q
600 80500 60400 40300 20200 0
SUPPLY SCHEDULE
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Law of Supply A decrease in the price of a good, all other
things held constant, will cause a decrease in the quantity supplied of the good.
An increase in the price of a good, all other things held constant, will cause an increase in the quantity supplied of the good.
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Change in Quantity Supplied
Quantity
Price
P1
Q1
P0
Q0
A decrease in price causes a decrease in quantity supplied.
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Change in Quantity Supplied
Quantity
Price
P0
Q0
P1
Q1
An increase in price causes an increase in quantity supplied.
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Shift in Supply Curve is represented by a movement of the entire supply curve.
Factors affecting the supply curve Change in Production Technology Change in Input Prices Change in the Number of Sellers
SHIFT IN SUPPLY CURVE
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Quantity
Price
P0
Q1Q0
An increase in supply refers to a rightward shift in the market supply curve.
SHIFT IN SUPPLY CURVE
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Quantity
Price
A decrease in supply refers to a leftward shift in the market supply curve.
P0
Q0Q2
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Change in price of a good or service leads to Change in quantity demanded movement along a demand curve
Change in income, preferences, or prices of related goods and services
leads to Change in demand shift of demand curve
Shift of Demand Versus Movement Along a Demand Curve
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Change in price of a good or service leads to Change in quantity supplied movement along a supply curve
Change in costs, input prices, technology, or prices of related goods and services
leads to Change in supply shift of supply curve
Shift of Supply Versus Movement Along a Supply Curve