Theories of profit

Economic profit is the payment for entrepreneurial ability – whatever that is. The entrepreneur is rewarded for recognizing a profit opportunity and taking advantage of it. There are four somewhat overlapping theories of how the entrepreneur earns a profit: (1) as a risk taker; (2) as an innovator; (3) as a monopolist; and (4) as an exploiter of labor.

Profit as a pay for input

Rent. Land is a resource or a factor of production. The owner of land is paid rent for allowing its use in the production process. The amount of rent paid for a piece of land is based on the supply of that land and the demand for that land.

To summarize, location is the basic differentiating factor in the rents of various plots of land, and how much rent is paid is determined by the demand for each piece of land.

Capital. Capital consists of office buildings, factories, stores, machinery and equipment, computer systems, and other synthetic goods used in the production process. When we invest, we are spending money on new capital. When we build an office park, a shopping mall, or an assembly line, or when we purchase new office equipment, we are engaged in investment.

The interest rate is determined by the law of supply and demand.

The net productivity of capital

The concept of net productivity of capital, which translates into the expected profit rate:

Sales — Costs (including a normal profit) = Dollar value of net productivity

Net productivity of capital =Dollar value of net productivity / Capital cost

The capitalization of assets

Value of asset = Annual income from asset/ Interest rate

Lecture 7. Production possibilities and opportunity cost

1. Resources, technology, and production possibilities.

2. Production possibilities curve.

3. Law of increasing opportunity cost.

4. Economic growth: expanding production possibilities.

1. Resources, technology, and production possibilities

Production is the process of using the services of labor and other resources to make goods and services available. These goods and services are called outputs.

Economic resources are the inputs used in the process of production. They are divided into four broad categories:

1. Labor.

2. Capital.

3. Natural resources including land.

4. Entrepreneurship.

2. Production possibilities curve

You'll see the problem of scarcity more clearly with the aid of a simple model whose purpose is to examine the relationship between the production of goods and services and the availability and use of resources. In the analysis we make the following assumptions:

1. The quantity and quality of economic resources available for use during the year are fixed.

2. There are two broad classes of outputs we can produce with available economic resources.

3. Some inputs are better adapted to the production of one good than to the production of the other.

4. Technology is fixed and does not advance during the year.

Some resources have a comparative advantage over other resources – the ability to be better suited to the production of one good than to the production of another good.

Given available resources, their quality, and current technology, there is a limited amount of any one good that can be produced in an economy given the output of other goods.

A production possibility table is a table that lists a choice’s opportunity costs by summarizing what alternative outputs you can achieve with your inputs. This table lists the different combinations of two products which can be produced with a specific set of resources (and with full employment and productive efficiency) (table 7.1).

A production possibilities curve shows the maximum possible output for one good that can be produced with available resources, given the output of the alternative good over a period (fig. 7.1).

The curve shows the options available to produce various combinations of goods and services under current technology during a year, assuming the resources are fully utilized.