Types of profit
The invisible hand
Today: Some fundamental ideas
that are important to every
economist
Applications of supply and
demand
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Today, we will continue to apply what
we have learned about supply and
demand
We will also introduce various ideas
about profits and see another way to
reach market equilibrium
Assumptions for today’s
lecture
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Property rights
Free entry and exit
Many potential sellers
Many potential buyers
Questions of the day
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Why are TV
repair shops
harder to find?
Why has Las
Vegas added
many expensive
hotels on its
famous strip?
Answer
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The invisible hand
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We will see how much profit is “enough”
for firms to stay in business
When profits exceed this, other firms will
enter
When profits are lower than this, firms will
leave
Today
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We will compare different types of
profits
We will find the point where marginal
benefit of consumption equals the
marginal cost of production
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This will give us the efficient outcome
Business and profit
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Each business has revenues and costs
The difference between these is profit
Profits that you typically hear about are
what are called “accounting profits”
These profits do not account for
opportunity costs
From total revenue to profits
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Total revenue =
Explicit costs + Accounting Profit =
Explicit costs + Normal Profit + Economic Profit
Normal profit is an implicit cost
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Defined as the “the opportunity cost of the resources
supplied by a firm’s owners” (p. 219)
Example: Jill
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Jill the plumber
She could either run
a home business or
work next door at
AAA Plumbing at $30
per hour
Either way:
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40 hours / week
50 weeks / year
Jill’s potential home business
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If she works at home, she assumes that
her annual revenues and costs will be
as follows
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Total revenue: $200,000
Explicit costs: $160,000
What should Jill do?
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Jill should run a home business if her
economic profit is positive
Economic profit is total revenue minus
all costs (including opportunity cost of
not working)
Economic profit =
$200,000 – ($160,000 + $60,000) =
– $20,000
Jill’s Conclusion
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Jill should work at AAA plumbing, since
her economic profit of working at home
is negative
Notice that the accounting profit is
positive if Jill opens her business, but
she can earn more as a plumber
Next: Long-run equilibrium
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Remember that a firm’s short-run
equilibrium will occur when MB (which
is price in this case) equals MC
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Exception: Shut-down condition
Now we will see how we get long-run
equilibrium
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Notice in the long run there are no fixed
costs
For this discussion
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Assume that costs include implicit costs
Thus, we are calculating economic
profit
Equilibrium occurs when economic
profit is zero
Example: Start at supply S
Positive profits, since P > ATC
Market supply
Firm supply
What happens when economic
profits are positive?
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New firms enter the industry
Supply shifts to the right
Market price decreases
Market quantity increases
What else happens?
What happens to the firm
from the price drop?
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Each firm produces less, since some units
produced are no longer profitable
Profits fall, since each unit produced has
lower profit than before
Economic profits are often driven to zero in
the long run
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ATC is minimized when long-run profits are zero if
each producer has the same ATC curve
Prediction: Supply continues to
shift until economic profits are 0
Why do we predict a zero
profit in the long run?
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If economic profits are positive in a
market, some firms will be able to make
more economic profits in this market
than in other markets
If economic profits are negative in a
market, some firms already producing
in this market can make more economic
profit producing another good
Back to our questions
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Why are TV
repair shops
harder to find?
Why has Las
Vegas added
many expensive
hotels on its
famous strip?
Why are TV repair shops
harder to find?
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When televisions
were first produced,
it was a major
purchase
When the TV broke,
fixing it was usually
a much lower cost
than replacing it
Why are TV repair shops
harder to find?
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Today, some flat screen TVs will cost
you less than a dinner for 2 at an
expensive restaurant
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Example: $140 for a 20” flat-screen at
Target (checked 1/15/08)
Repairing a TV today may cost more
than replacing it
Why are TV repair shops
harder to find?
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As the price of TVs (relative to yearly
income) falls, fewer people will have
their TVs repaired when it breaks
Fewer repairs  Lower economic profit
Whenever economic profit becomes
negative, some firms will not renew
their leases
Las Vegas Mega resorts
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In recent years, many large hotels have
opened on the Las Vegas strip
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Bellagio
Mandalay Bay
Wynn Las Vegas
MGM Grand
New York/New York
Why all of the new hotels?
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Las Vegas is not only a
gambling hotspot, but also
has become an entertainment
destination
Shopping for any budget is
available on the strip
Some dining choices are
world class
Pinot Brasserie at
the Venetian 
Example: Caesars Palace
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Billion dollar expansion announced July
2007
Shopping and entertainment options
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The Forum Shops
Bette Midler
Elton John
Jerry Seinfeld
Some Las Vegas facts
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From USA Today, 2/14/07
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38.9 million visitors in 2006
137,600 hotel rooms (expected to grow to
171,000 by 2010)
Hotel occupancy of 89.7%
Hotel inventory stayed about the same in
2006
Average room price increased by 16% in
2006
What happened?
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In 2006, the Stardust closed to make way for
a new resort, Echelon Place
The Boardwalk also closed to make way for
new projects
Off-strip hotels of (arguably) comparable
quality opened in 2006
Increased demand for hotel rooms and shortrun decrease in supply forced prices to go up
by 16% in Las Vegas
What is happening in Las
Vegas?
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Short-run positive economic profits are
currently likely in Las Vegas
Once new resorts open, economic
profits will likely converge toward zero
Depending on demand, prices for hotel
rooms may decline when new hotels
open
Summary
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Without government intervention, free
entry and exit can lead to a long run of
zero economic profit
Opportunity cost is important in
calculating economic profit