Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 5 Firm Behavior
and the Organization of Industry
Chapter
14 of 36 Firms In Competitive Markets
Section
21 of 24
…
Table
A here
…
Why
do firms in competitive markets stay in business if they make zero profit at
price = average total cost?
It
is because average total cost includes implicit cost.
Accountants
calculate explicit costs that cause a money flow but do not consider implicit
costs which do not.
Per
Table A, year 1
A
farmer’s sales revenue for the year is $250,000 and explicit costs of $150,000.
The
farmer's accountant calculates he earns an accounting profit of A – B =
$100,000
…
Originally
the farmer invested $1,000,000 to start his farm.
He
could have instead put his money in the stock market for an average profit of
5% producing a yearly income of $50,000.
He
also had to give up a job that paid a salary of $50,000.
These
two $50,000 + $50,000 = $100,000, are implicit non-cash-flow costs.
Considering
the farmer’s implicit forgone stock market and wages opportunity costs,
economic profit in year 1 is C – D = $0
He
stays in the farming business because both explicit and implicit costs are
covered.
…
In
year 2 his revenue increases to $275 and he makes a $10,000 economic profit.
In
year 3 his revenue falls to $225,000 and he incurs a $10,000 economic loss.
After
year 3 the farmer will continue farming only if he expects in the future he
will average at least $0 economic profit, otherwise he will exit the market.
… …
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