Profit Flashcards
What is accounting profit?
Total Revenue - Total (production) costs
What is economic profit
Accounting profit - opportunity cost
Value of the next best alternative foregone
Where on a total cost/total revenue graph is profit max
Largest gap between TR and TC
Why is it profit max when MC=MR
It is the last point at which MR is above has had the biggest increase in revenue.
Biggest difference between TR + TC
Shutdown conditions if AR is greater than ATC
Supernormal profit is being achieved - business should continue to operate
Shutdown conditions if AR is lower than ATC but above AVC
Would make more of a loss if shut down now - continue producing to minimise the loss
Shutdown in the long run
Shutdown conditions if AR is lower than ATC and AVC
Shut down NOW
Know how to draw a cost/revenue diagram
AR = D
MC = S
Profit maximising = MC = MR
x = Output
Know how to draw a perfect competition cost/revenue
Flat AR = MR
Conditions for a perfectly competitive market
- Lots of firms (all with a small market share)
- Perfectly homogenous goods (no differences)
- Price takers (no price making ability, flat AR curve)
- Perfect information
- No patents (entry or exit barriers)
- Agents act rationally
Examples of ‘perfectly’ competitive markets? (3)
- Gold
- Oil
- Currency
Why is a perfectly competitive market almost impossible?
There is always branding, service, ease, size of firms
Why is asymmetric information largely solved?
The internet
Can there be a shift in AR curve?
Yes - only in the short run
What is economic efficiency?
MC = AR
Marginal cost shows the cost of an additional unit of output, reflecting the value of an additional unit
Average revenue shows the Demand for that firms product (i.e price consumers are willing to pay), which reflects the MPB consumers receive from this additional unit.
Why is MC = AR economic efficiency?
It is welfare maximising
If MC > AR why is it bad?
The resources used have had value subtracted
- scarce resources so bad!!
If AR > MC why is it bad?
The price consumers are willing to pay at less than the cost
- each unit is adding welfare, so going towards AR=MC more welfare is added but by less each time
Why are perfectly competitive markets alloctively efficient?
MC always equals AR
What is Productive efficiency?
ATC = MC
Level of output where ATC was minimised
Firm is using the fewest resources possible
Productive efficiency in PC markets?
Firms are price takers
Firms have to work at the lowest ATC because its the only thing they control is cost
It is profit max, occurs when costs are minimised
What is X-inefficiency?
When a lack of competitive pressures result in an organisational slack (inefficiencies in terms of management decisions that don’t minimise costs)
Why are firms X-inefficient?
Principal agent problem (divorce of ownership)
Why are PC markets never X-inefficient?
There is the highest degree of competitive pressures
No organisational slack - if there were then costs > revenue
What is Dynamic efficiency?
Changes in static efficiencies
Normally derived from investments, which result in innovation
What does dynamic efficiency rely on?
- Incentive to invest: competitive pressures
- Ability to invest: Profits
Dynamic efficiency in PC markets?
Yes incentive to invest
No ability to invest
Reasons to revenue maximise (MR = 0)?
Market share + brand loyalty
Managers objectives being different to owners objectives
What scenarios is a principal-agent problem likely to occur?
- Large firm?
- Owners part in the management?
- Technical knowledge of the owner?
- Owner’s access to data?
Reasons to sales maximise (AR = AC)?
- Market share + Brand loyalty
- Charities
- Sustainability + jobs for people
What is profit satisficing?
Enough profit to satisfy owners/shareholders, BUT not profit maximising
