Competitive Market
Elements of Economics
Business Enterprises and the Profit
Motive
Business Enterprise: a social institution
organized informally or organized through the
use of legal procedures by an individual or a
group of individuals pulling together their
financial and other resources to perform different
kinds of activities for productive and distributive
purposes in expectation of a monetary return to
their activities. They perform their productive and
distributive activities by organizing factor or
productive inputs to transform intermediate
inputs or raw materials into new products and
services
Types of Business Enterprises
Micro enterprise: household-based small
businesses under sole proprietorship (one owner)
Partnership: business enterprise or agreement
between 2 or more people with joint ownership
and liabilities of a business
Corporation: created under the operation of law
giving the enterprise a legal personality. Allowed
by law to generate funds for the operation of the
business from the contributions of major
stockholders as well as funds generated by selling
of stocks to the public and from borrowing.
Types of Corporations
Stock vs Nonstock
Stock corporations: capital for operation is raised from
funds generated in the issuance and selling of stocks to
the public
Nonstock corporations: funded by nonissuance of
stocks to the public
Profit vs Nonprofit
Corporations for profit: surplus is distributed in terms of
dividends to the major shareholders as well as to other
people who are holding the stocks of the corporation
Nonprofit corporations: surplus goes back to the
corporation and are not distributed to its owners
Profit as Incentive
Profit is an incentive for businessmen to
continue doing business in a particular
industry.
Can be considered as information that
guides owners of productive inputs where
and which industries to employ their
resources as factors of production to reap
higher profit.
Profit as Income and Cost
Profit is a surplus income generated by the
business enterprise for the efficient and effective
management of the business.
Profit can also be considered as a cost of
production since it is a compensation for the use
of the talents of owners and managers in taking
the various risks and uncertainties in operating a
business.
Normal Profit: typical return that resources of
owners would have earned in other activities
Concept of Accounting Profit
Concept of Profit: difference between total
revenue and total cost (TR-TC)
Total revenue = Price x Quantity Sold
Total cost: accounting + economic costs
Accounting Costs: explicit costs of production
since there are monetary outlays in the use of
factors of production.
Accounting Profit: based on the difference
between total revenue and total explicit costs
Concept of Economic Profit
Economic Costs: includes both explicit and
implicit costs in the use of the factors of
production. Part of the implicit costs are the
opportunity cost of factor inputs especially when
there are no explicit monetary outlays involved
in the employment of factors.
Economic Profit: based on the difference
between total revenue and total explicit and
implicit costs.
Accounting Profit and
Economic Profit
Total Revenue 1,000,000
Explicit Costs 760,000
Cost of Raw Materials 500,000
Salary 200,000
Utilities 50,000
Tax 10,000
Net Income/Accounting Profit 240,000
Implicit Costs 350,000
Salary of Owner (former job) 150,000
Return of Investment (if put in bank)
(10% per year = 2,000,000) 200,000
Explicit Costs + Implicit Costs 1,110,000
Economic Profit (Loss) -110,000
Profit as an Economic Cost
Using the concept of opportunity costs, profit can
be considered as cost since the owners of the
business can earn alternative return or a normal
profit if they have placed their resources in other
business activities.
Normal profit: an average return in several
business enterprises. Measured by estimating the
alternative value or opportunity cost of using
funds, investments, time, and abilities of the
investor in other business options.
Abnormal profit/ economic profit: profit earned by a
company that exceeds the normal return
Characteristics of a Competitive
Market
Concept of Competition
No single seller or single buyer has control in
determining the market price and quantity
Many Buyers and Sellers
The decision of a single buyer to purchase or not will
not have an impact on the market price.
The production decision of a single producer will not
have a significant effect in changing the supply of the
product.
Selling Homogenous Products
Consumers are indifferent in the products offered.
Characteristics of a Competitive
Market
Free Entry and Exit in the Market
Competitor firms (many are small businesses) can
easily enter the market. When the market is
unfavorable, it is easy for them to exit.
Free Flow of Resources
There are no barriers that prevent factors of
production in moving to the best alternative activities.
Complete Information
Information must be known to all actors in the market.
Competitive Market and
Maximization of Profit
Conditions for Profit Maximization: The highest
profit can be determined if the difference
between the total revenue (TR) and total cost
(TC) is at maximum.
Another way of attaining this condition is when
the marginal revenue is equal to marginal cost.
If marginal profit is zero, maximum profit has
been reached because the total profit is no
longer changing from its previous peak.
Difference between Total Cost (TC)
and Total Revenue (TR)
TR-TC = Profit, QxP = TR
MR = MC Marginal Profit = 0, Since P (price) is also MR, we can
say that the profit maximizing condition is P = MC
MR is the additional revenue due to a change in output
MC is the change in cost due to a change in output
MP is the change in profit as a result of a change in output
Profit Maximization Graphs
Using Totals
Profit Maximization Graphs
Using
Marginals
Break-even and Shutdown Points
Break-even = a firm is earning enough profits to
cover all its expenses when the average total
cost (total cost in producing 1 unit of good,
AC=TC/Q), marginal cost and marginal revenue
are equal. The break-even price is simply the
marginal revenue.
Once the firm has overcome the stage of break-
even, that is the time when it earns positive
profits.
However, when the AC exceeds the profit
maximization point (MR=MC), it is better for the
firm to shutdown instead of operating at a loss.
