Profit is the reward which goes to organization as a factor of production for its participation in the process of production. Profit in its pure accounting sense is the surplus of revenue over the cost. Thus, P = TR – TC We have also studied that every business enterprise desires to maximize its profit. The condition for profit maximization is the level of output where Marginal Revenue = Marginal Cost. We also differentiate between normal profit and super normal profit i.e. normal profit is included in average cost whereas any profit above the average cost is super normal profit. We have also considered the concepts of gross profit and net profit besides profit in accounting sense, which considers only explicit cost whereas in economic sense to consider profit we take note of both explicit and implicit costs. The firm has also to reveal to its shareholders the profit Continue reading
Economics Principles
Application of Economics to Business Management
Managerial economics is the discipline, which deals with the application of economic theory to business management. Managerial Economics thus lies on the margin between economics and business management and serves as the bridge between the two disciplines. The application of economics to business management or the integration of economic theory with business practice, as Spencer and Siegelman have put it, has the following aspects : Reconciling traditional theoretical concepts of economics in relation to the actual business behavior and conditions: In economic theory, the technique of analysis is that of model building. This involves making some assumptions and, drawing conclusions on the basis of the assumptions about the behavior of the firms. The assumptions, however, make the theory of the firm unrealistic since it fails to provide a satisfactory explanation of what the firms actually do. Hence, there is need to reconcile the theoretical principles based on simplified assumptions with Continue reading
The Circular Flow Model of the Economy
The circular flow model is used to represent the monetary transactions in an economy. It helps to show connections between different sectors of an economy. It shows flows of goods and services and factors of production between firms and households. The circular flow of income is a model that helps show the movement of income and spending throughout the economy. In the economy, households help provide firms with factors of production, e.g. labour. Organisations use these factors to provide goods and services to the household. The households will then spend their money on the goods and services provided by the firms. This money is use by the firms to pay the households for the work they provide, through wages. This process will repeat itself and then form the circular flow of income. There are two main flows within the model shown above, the flow of physical things, e.g. Good and Continue reading
Understanding Akerlof’s “Lemon Market Theory”
The Lemon Market Theory (LMT) explained by Nobel Prize winner George A. Akerlof in 1970 in his seminal paper, “The Market for Lemons: Quality Uncertainty and the Market Mechanism” describes how markets that sell good products is never identified because of poor quality supplying markets, as sellers of the poor quality products are provided incentives to sell their products. Incentives such as guarantees, warranties and brand names oppose the quality uncertainty issue. The Lemon Market Theory also focuses on the information asymmetry or unbalanced information between the buyer and seller, where the entire set of sellers take the credit for the quality of the product or service rather than granting the individual quality reward to the appropriate seller who provides the good quality ones. This result in extinguishing the existence of good quality sellers from the market because their product’s quality or service is never recognized or identified and they Continue reading
Conflicts with Firms Profit Maximization Objective
Profit maximization is the most popular hypothesis in economic analysis, but there are many other important objectives, which are not to be avoided by any firm. Modem business firms pursue multiple objectives. An important aspect of profit is its use in measuring and controlling performances of the individuals of the large business firms. Researches have concluded that the business individuals of middle and top management often deviate from profit objective and try to maximize their own utility functions. They give importance to job security, personal ambitions for promotion, larger perks, etc. But this often conflicts with firms profit-making objective. The reasons for conflicts are as follows: More energy is spent in expanding sales volume and product lines than in raising profitability. Subordinates spend too much time and money doing jobs perfectly regardless of its cost and usefulness. Individuals depend more to the needs of job security in the absence of Continue reading
Applications of the Price Elasticity of Demand
The concept of elasticity of demand plays a crucial role in the pricing decisions of the business firms and the Government when it regulates prices. The concept of price elasticity is also important in judging the effect of devaluation of a currency on its export earnings. If has also a great use in fiscal policy because the Finance Ministry has to keep in view the elasticity of demand when it considers to impose taxes on various commodities. We shall explain below the various uses, applications and importance of the elasticity of demand. Elasticity of demand is mainly useful in Pricing Decisions by Business Firms. The business firms take into account the price elasticity of demand when they take decisions regarding pricing of the goods. This is because change in the price of a product will bring about a change in the quantity demanded depending upon the coefficient of price elasticity. Continue reading