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PROFIT THEORY

PROFIT THEORY . IB ECONOMICS – A COURSE COMPANION (Blink & Dorton , 2007). PROFIT THEORY . How economist’s measure profit is different to accountants, because of the issue of opportunity cost.

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PROFIT THEORY

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  1. PROFIT THEORY IB ECONOMICS – A COURSE COMPANION (Blink & Dorton, 2007)

  2. PROFIT THEORY • How economist’s measure profit is different to accountants, because of the issue of opportunity cost. • For example, a person might be making $80,000 a year profit from running their business, but they were making $80,000 a year as marketing manager before they started to run their own business. Running a business may involve more stress, and higher levels of uncertainty.

  3. PROFIT THEORY How do economists measure profit? Total Profit = Total revenue – total cost (fixed, variable and opportunity cost)

  4. PROFIT THEORY Normal Profit • If total revenue is equal to total cost, the firm is making normal profit. Abnormal Profit • If total revenue is greaterthan the total cost, the firm is making abnormal profit. Losses • If total revenue is less than total cost, then the firm is making losses.

  5. PROFIT THEORY – EXAMPLES

  6. Table Analysis – Firm A • A firm is making an abnormal profit of $20,000. • This means that the revenue earned by the firm is not only covering all the costs, but it is in fact $20,000 more. • This will make the entrepreneur happy, as he/she was expecting to cover her opportunity cost of $60,000 and in fact gets $80,000.

  7. Table Analysis – Firm B • Firm B is making normal profit. • The revenue earned by the firm exactly covers all the costs. • The entrepreneur will be satisfied.

  8. Table Analysis – Firm C • Firm C is making losses. • Although an accountant would say that the firm is making a profit of $40,000 ($200,000-$160,000) the entrepreneur will not be happy. • Fixed and variable costs are covered, but opportunity cost is not covered. • The entrepreneur should close down the firm, moving to the entrepreneur’s next best occupation.

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