Distinguish between accounting profit, economic profit, and normal profit. Does accounting profit or economic profit determine how entrepreneurs allocate resources between different business ventures? Explain. Accounting profit is the profit that would appear on your accounting statement that you would report to the government for tax purposes. Economic profit is the result of subtracting all of your economic costs from revenue. By subtracting all of your economic costs for your revenue, you determine how your current business venture compares with your best alternative business venture. Normal profit is the typical amount of accounting profit that you would most likely have earned in another business venture. This number is what you would use to figure out the economic profit. The accounting profit overstates the economic success of your business because it ignores your implicit costs. The economic profit, on the other hand, does not ignore these nor the explicit costs. It is for this reason entrepreneurs would focus on economic profits rather than accounting profits to allocate resources between different business ventures.
Chapter 9, Problem 3 on p. 219
3. You are a newspaper publisher. You are in the middle of a one-year rental contract for your factory that requires you to pay $500,000 per month, and you have contractual labor obligations of $1 million per month that you can’t get out of. You also have a marginal printing cost of $0.25 per paper as well as a marginal delivery cost of $0.10 per paper. If sales fall by 20 percent from 1 million papers per month to 800,000 papers per month, what happens to the AFC per paper, the MC per paper, and the minimum amount that you must charge to break even on these costs?
• AFC per paper will increase from 1.50 to 1.875.
1. TFC = 500k+1M = 1.5M
2. AFC1 = 1.5M/1M = 1.500
3. AFC2 = 1.5M/800k = 1.875
• The MC per paper stays the same because costs per paper did not change. • And the minimum amount that you must charge to break even on these costs is $2.225. This is obtained by adding the Marginal Cost (MC) to the Average Fixed Cost (AFC).
Chapter 10, Problem 4 parts a, b, and c only on p. 238
Assume that the cost data in the following table are for a purely competitive producer:
a. At a product price of $56, will this firm produce in the short run? If it is preferable to produce, what will be the profit-maximizing or loss-minimizing output? What economic profit or loss will the firm realize per unit of output? At a product price of $56, this firm will produce at Q = 8
The profit-maximizing output would be $62.96
The economic profit the will firm realize per unit of output is $7.87 (= $56 – $48.13) b. Answer the questions of 4a assuming product price is $41. Total Product (Q)
At a product price of $32, this firm will not produce because $32 is always going to be less than the lowest AVC (37). If it were preferable to produce, the loss-minimizing output would be 4. Least difference between MR & MC. By producing 4 units, the firm would lose $82 [= 4 ($32 – $52.50)].
Chapter 11, Problem 2 on bottom of p. 252 (to top of p. 253)
2. A firm in a purely competitive industry is currently producing 1,000 units per day at a total cost of $450. If the firm produced 800 units per day, its total cost would be $300, and if it produced 500 units per day, its total cost would be $275. What are the firm’s ATC per unit at these three levels of production? If every firm in this industry has the same cost structure, is the industry in long-run competitive equilibrium? From what you know about these firms’ cost structures, what is the highest possible price per unit that could exist as the market price in long-run equilibrium? If that price ends up being the market price and if the normal rate of profit is 10 percent, then how big will each firm’s accounting profit per unit be?
What are the firm’s ATC per unit at these three levels of production? A. Total Cost = 450 / Output = 1,000 = ATC = .45
B. Total Cost = 300 / Output = 800 = ATC = .375
C. Total Cost = 275 / Output = 500 = ATC = .55
If every firm in this industry has the same cost structure, is the industry in long-run competitive equilibrium? In long-run equilibrium a triple equality occurs: P = MC = minimum ATC. So the answer is no, because the firm is currently producing an output of 1,000 units per day with a total cost of $450. This means the firms Average Total Cost is .45 which is more than the lowest ATC of .375.
From what you know about these firms’ cost structures, what is the highest possible price per unit that could exist as the market price in long-run equilibrium? Productive efficiency requires that goods be produced in the least costly way. In the long run, pure competition forces firms to produce at the minimum average total cost and to charge a price that is just consistent with that cost. In this instance, the highest possible price per unit would be at the ATC of .375.
If that price ends up being the market price and if the normal rate of profit is 10 percent, then how big will each firm’s accounting profit per unit be? ATC of $0.375 * .10 = $0.0375 per unit or $0.038.