Econ 101: Chapter 15 Flashcards
Accounting profit
the total revenue a business receives, minus its explicit out of pocket financial costs.
total revenue
all of the income received from all sources.
explicit financial costs
all the money that leaves your business (rent, wages, cost of raw materials)
Accounting profit =
total revenue - explicit financial costs
implicit opportunity costs
includes forgone wages and forgone interest
economic profit
the total revenue a firm receives, minus both explicit financial costs and the entrepreneurs implicit opportunity costs.
Economic profit =
total revenue - explicit financial costs - implicit opportunity costs
Why do accountants and economists disagree on what profit is?
Accountants want to follow where the money goes.
Economists want to make the best decision.
Average revenue
the revenue per unit
average revenue is equal to
price, if you charge everybody the same price.
Average revenue curve is also the
firm demand curve.
average revenue =
(total revenue / quantity ) = price
average cost
the cost per unit
Average cost =
(total cost / quantity) = (fixed cost / quantity) + (variable cost / quantity)
fixed cost
expenses that don’t vary with the quantity you produce.
variable cost
vary with the quantity you produce.
spreading your fixed cost
As you produce a larger quantity, the fixed cost gets “spread” over more and more units.
rising variable cost
Inefficiencies make it increasingly expensive to increase your production.
profit margin
the profit per unit sold
profit margin =
average revenue (price) - average cost
short run
the time horizon over which the production capacity, and the number and type of competitors you face, cannot change.
long run
the time horizon over which you, or your rivals, may expand or contract production capacity and new rivals may enter the market or existing firms may exit.
Rational Rule for Entry
you should enter a market if you expect to earn a positive economic profit, which occurs when the price exceeds your average cost.
new competitors makes your business…
lose profit and market power
Rational Rule for Exit
exit the market if you expect to earn a negative economic profit, which occurs if the price is less than your average costs.
competitors leaving makes your business..
regain profit and market power
free entry
when there are no factors making it particularly difficult or costly for a business to enter or exit an industry.
free entry causes…
profitable markets to reach zero economic profit in the long run.
free exit causes…
unprofitable markets to reach zero economic profit in the long run.
Why is there a focus on average cost?
We are focused on the marginal supplier –> profit margin depends on average cost.
barriers to entry
obstacles that make it difficult for new firms to enter a market.
4 strategy types to outcompete and deter potential market entrants:
demand-side, supply-side, regulatory, deterrence
Demand side strategies include…
switching costs, reputation and goodwill, and network effects.
switching costs
an impediment that makes it costly for customers to switch to buying from another business.
network effects
make your product more useful the more people use it.
supply side strategies involve…
developing unique cost advantages.
devlop unique cost advantages by…
learning by doing, mass production, research and development, relationships with suppliers, and access to key inputs.
regulatory strategies involve…
mobilizing the government
patents
(regulatory strategy) give you the right to be the only producer; no other company can use your idea without your permission.
regulatory strategies can be…
patents, government regulations to starting a business, compulsory licenses, lobbying.
deterrence strategies involve…
convincing potential entrants you’ll crush them.
brand proliferation
the process of creating multiple brands under one parent company.
brand proliferation ensures that…
there are no profitable niches for a rival to exploit.
pro-market policies
ensure that consumers enjoy the benefits of robust competition in the market.
pro-business policies
help existing businesses, often at the cost of destroying opportunities for potential new entrants.
long run equilibrium
where the firm demand curve just touches the average cost curve.
