2. dd & ss
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Lecture 3
Nature of Economic ProfitEconomic RelationshipsDemand & Supply
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NATURE AND FUNCTION OF PROFIT
Difference between the revenues earned from thesale of goods and services and the costs incurred inearning these revenues
Profit = Revenues Costs
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Revenues and CostsRevenue is the income earned by a firmthrough its normal course of business
Costs Explicit costs are the actual out of pocket
expenditures of the firm to purchase/ hire theinputs it requires in production
Implicit costs refer to the value of the inputsowned and used by the firm in its own productionprocesses
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Definitions of Profit
Accounting/Business Profit: Total revenueminus the explicit or accounting costs ofproduction.
Economic Profit: Total revenue minus theexplicit and implicit costs of production.
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Example:A graduate turns down a job offer at Rs. 60,000 per year to starthis own venture. He is considering investing Rs. 200000 of his ownmoney, which has been in a bank account earning 5% per year. Theprojected income statement for the year as prepared by anaccountant is:
Income statement prepared by an accountant:
(in Rs)
Sales 90,000Less cost of goods sold 40,000Gross Profit 50,000
Less: Advertising 10,000
Depreciation 10,000Utilities 3,000Property Tax 2,000
Misc. expenses 5,000 30,000
Net accounting profit 20,000
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Implicit costs
Rs.200000 invested in business can earninterest in the bank account @ 5% per year
Annual wage of a graduate being Rs.60000 peryear
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Income statement prepared by an economist:(in Rs)
Sales 90,000Less cost of goods sold 40,000
Gross Profit 50,000Less: Advertising 10,000
Depreciation 10,000Utilities 3,000Property Tax 2,000
Misc. expenses 5,000 30,000Net accounting profit 20,000
Net economic profit -50,000
Less: Implicit costs:Return on 200000of invested capital 10,000Forgone wages 60,000
70,000
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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 aspecified period of time using a particular input
Average product - the average output per unit of inputused
AP = TP / L
Marginal product - is the change in the TP correspondingto one unit change in the input.
MP = D TP / D L
TOTAL AVERAGE MARGINAL
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Number o Total Average MarginalWorkers Product Product Product
(L) (Q) (AP) (MP)0 0 0 0
1 2 2.0 2
2 5 2.5 3
3 9 3.0 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 69 64 7.1 1
10 63 6.3 -1
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Number o Total Average MarginalWorkers Product Product Product
(L) (Q) (AP) (MP)0 0 0 0
1 2 2.0 2
2 5 2.5 3
3 9 3.0 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 69 64 7.1 1
10 63 6.3 -1
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Number o Total Average MarginalWorkers Product Product Product
(L) (Q) (AP) (MP)0 0
1 2 2.0 2
2 5 2.5 3
3 9 3.0 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 69 64 7.1 1
10 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 11 Rate of Labor Input
T o
t a l P
r o d u c
t
AVERAGE & MARGINAL PRODUCT FUNCTIONS
-5
0
5
10
15
20
0 1 2 3 4 5 6 7 8 9 10 11 Rate of Labor Input A
v e r a g e
& M a r g
i n a
l P r o
d u c
t
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 11 Rate of Labor Input
T o
t a l P
r o d u c
t
AVERAGE & MARGINAL PRODUCT FUNCTIONS
-5
0
5
10
15
20
0 1 2 3 4 5 6 7 8 9 10 11 Rate of Labor Input
A v e r a g e
& M a r g
i n a
l P r o
d u c
t
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 11 Rate of Labor Input
T o
t a l P
r o d u c
t
AVERAGE & MARGINAL PRODUCT FUNCTIONS
-5
0
5
10
15
20
0 1 2 3 4 5 6 7 8 9 10 11 Rate of Labor Input A
v e r a g e
& M a r g
i n a
l P r o
d u c
t
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 DesireDemand for a commodity by a consumption unit isthe quantity it would buy in a given period of time
at a given priceDeterminants of Demandprice of the productlevel of income and wealth
prices of other productstastes and preferencesexpectation of future income
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Individual Consumers Demand Qd X = f(P X, I, P Y, T)
quantity demanded of commodity Xby an individual per time period
price per unit of commodity Xconsumers income
price of related (substitute orcomplementary) commodity
tastes of the consumer
Qd X =
P X =I =
P Y =
T =
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Demand Schedule- A table showing how much of a givenproduct a consumption unit would be able to willingly buyat different prices
Demand Schedule for telephone calls
Price per Calls percall month
P Q0 30
0.5 25
3.5 7
7 3
10 1
15 0
DEMAND SCHEDULE
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Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
An increase in pricecauses a decrease inquantity demanded.
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Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
A decrease in pricecauses an increase inquantity demanded.
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Shift in Demand is represented by amovement of the entire demand curve.Factors affecting the demand curve :Change in Buyers Tastes
Change in Buyers IncomesNormal GoodsInferior Goods
Change in the Price of Related GoodsSubstitute GoodsComplementary Goods
SHIFT IN DEMAND CURVE
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Quantity
Price
P0
A decrease in demandrefers to a leftward shiftin the market demandcurve.
Q2 Q0
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SUPPLY SIDE OF THE MARKET
Supply is the amount of product that a firm would bewilling and able to offer for sale at a particular priceduring a given period of time.
Determinants of supplyprice of the productcost of production
price of required inputs
technologiesprices of related products
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Supply schedule- A table showing how much of a productfirms will supply at different prices
Supply Schedule for telephones in a month
Price per productionunit per monthP Q
600 80
500 60400 40
300 20
200 0
SUPPLY SCHEDULE
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Law of SupplyA decrease in the price of a good, all otherthings held constant, will cause a decrease inthe quantity supplied of the good.
An increase in the price of a good, all otherthings held constant, will cause an increase inthe quantity supplied of the good.
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Change in Quantity Supplied
Quantity
Price
P1
Q1
P0
Q0
A decrease in pricecauses a decrease inquantity supplied.
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Change in Quantity Supplied
Quantity
Price
P0
Q0
P1
Q1
An increase in pricecauses an increase inquantity supplied.
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Shift in Supply Curve is represented by amovement of the entire supply curve.
Factors affecting the supply curve
Change in Production TechnologyChange in Input PricesChange in the Number of Sellers
SHIFT IN SUPPLY CURVE
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Quantity
Price
P0
Q1 Q0
An increase in supplyrefers to a rightward shiftin the market supply curve.
SHIFT IN SUPPLY CURVE
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Quantity
Price
A decrease in supply refers
to a leftward shift in themarket supply curve.
P0
Q0 Q2
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Change in price of a good or serviceleads to
Change in quantity demandedmovement along a demand curve
Change in income, preferences, or prices of related goodsand services
leads toChange in demandshift of demand curve
Shift of Demand Versus Movement Along a Demand Curve
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Change in price of a good or serviceleads to
Change in quantity suppliedmovement along a supply curve
Change in costs, input prices, technology, or prices ofrelated goods and services
leads toChange in supplyshift of supply curve
Shift of Supply Versus Movement Along a Supply Curve
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