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P. 107

Economic Theory

                                                              TR
                                                      AR          .                                          (8.11)
                                                               Q


                  Remember that revenue is not the same as profit. Earlier we discussed

            the differences between implicit and explicit costs. Revenue is simply the
            amount of monetary flow that is handled by a firm as compensation for its
            product.
                  A  firm’s  profit  is  determined  by  subtracting  all  costs  (implicit  and

            explicit) from revenue.
                  Economic  profit  is  the  profitability  measurement  that  calculates  the
            amount that revenues received from selling a product exceeds opportunity

            costs  incurred  from  using  resources  to  make  and  sell  these  products.  In
            other words, it’s the excess money a company earned from one course of
            action over another had they chosen differently.

                  For the most part, we will assume that owners of firms endeavor to
            maximize total economic profit, where economic profit (Pr) is defined as
            the difference between total revenue (TR) and total economic cost (TC),

            that is:

                                                   Pr   TR    TC.                                        (8.12)


                  Profit  is  the  engine  of  maximum  production  and  efficient  resource
            allocation in pure capitalism; it’s can’t be underestimated. The existence of
            profit  opportunities  represents  the  crucial  signaling  mechanism  for  the

            dynamic  reallocation  of  society’s  scarce  productive  resources  in  purely
            capitalistic  economies.  Rising  profits  in  some  industries  and  declining
            profits  in  others  reflect  changes  in  societal  preferences  for  goods  and
            services.  Rising  profits  signal  existing  firms  that  it  is  time  to  expand

            production  and  serve  as  a  lure  for  new  firms  to  enter  the  industry.
            Declining profits, on the other hand, a signal producers that society wants
            less  of  a  particular  good  or  service,  presenting  existing  firms  with  an

            incentive  to  reduce  production  or  to  exit  the  industry  entirely.  In  the
            process,  productive  resources  move  from  their  lowest  to  their  highest
            valued  use.  Moreover,  profit  maximization  not  only  encourages  an

            efficient  allocation  of  resources,  but  also  implies  efficient  (least-cost)
            production.  Thus,  purely  capitalist  economies  are  characterized  by  a
            minimum waste of societys’ factors of production.





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