Economic Profits and Industry Entry

Key Concepts

• Economic Profits: Occur when business opportunities beat all other opportunities available.
• Firms Enter Industry: If they believe they can make positive economic profits, steering resources to high-value uses.

Cost Graphing

• Axes:
  • Vertical: Dollar value of costs.
  • Horizontal: Quantity produced.
• Marginal Cost (MC):
  • Initially drops due to economies of scale.
  • Eventually rises due to diminishing returns and rising opportunity costs.
• Average Costs (AC):
  • Includes fixed costs, starts higher than MC.
  • Falls when MC < AC, rises when MC > AC.
• Marginal Revenue (MR): Flat line at the price of the product.

Profit Maximizing Rule

• Intersection of MR and MC: Determines the quantity of production.
  • Example: At 60,000 units, MC = MR = $0.50.
  • Profit = (Price - Average Cost) x Quantity.
• Example Calculation:
  • Profit = $12,000, as AC is $0.30 per unit.

Impact of Competition

• Attraction of New Firms: Positive economic profits attract competition.
• Price Reduction: Increased competition lowers prices.
• Zero Economic Profits:
  • Occur when prices fall to average costs.
  • Firms earn zero economic profits but have accounting profits.

Zero Profit Condition

• Characteristics:
  • Perfect information: All firms know best production methods.
  • Free entry and exit: Low barriers for firms entering or exiting the industry.
• Outcome: Competition drives prices down, industries become more efficient, and economic profits are competed away.

Industry Types and Scale

• Decreasing Cost Industries: Large-scale production leads to lower costs (e.g., car manufacturing).
• Constant Cost Industries: Costs remain constant with scale (e.g., customer service).
• Increasing Cost Industries: Costs rise with output due to increasing opportunity costs (e.g., landscaping).

Long-Run Average Cost Curve

• Typical Manufacturing:
  • Starts with high costs, gains economies of scale.
  • Reaches a valley with constant costs, then increases with organizational costs and resource limits.
  • Example: Apple iPhone production.

Firm Theory Implications

• Industry Structure: Determines number and size of firms based on cost curves.
• Competition: Firms at minimum average cost out-compete others.