Profit Theories Group: The Learners

Syed Atta Hussain Shah (2k14/com/26)Sanjay Kumar (2k14/com/93)

Mian Iqrar Ahmed Soomro (2k14/com/126)Mujahid Bhanbhro (2k14/com/68)Dildar Ali Jamali (2k14/com/167)

Frictional Theory of Economic Profits

It states that markets are sometimes in disequilibrium because of unanticipated changes in demand or cost conditions.

Unanticipated shocks produce positive or negative economic profits for some firms.

Abnormal profits observed by unanticipated changes in demand or cost conditions.

Monopoly Theory of Profits:

Monopoly is a market structure in which there is only one producer/seller for a product.

This theory asserts that some firms are sheltered from competition by high barriers to entry.

Firms with monopoly power restrict output and charge higher prices than under perfect competition. This causes above-normal profits to be earned by the monopolistic firms.

Compensatory Theory of Economic Profits

Above-normal rates of return that reward efficiency.

It states above-normal rates of return that reward firms for extraordinary success in meeting customer needs, maintaining efficient operations, etc.

Innovation Theory of Economic Profits

This theory given by an “American economist Joseph Schumpeter”.

According to Schumpeter, the principal function of the entrepreneur is to make innovations and profits are a reward for successful innovations.

Innovation means think different from the rest.

Above normal profits arise because of successful innovations introduced by the entrepreneurs.

Above-normal profits that by successful invention or modernization

Innovation Theory of Economic Profits

Innovations may be of two types1. Those which change the production

function and reduce the cost of production. i.e. Introduction of new machinery, improved production techniques or processes.

2. Those innovations which stimulate the demand for the product, i.e., which change the demand or utility function.

Why Profits Vary: The main reason of inequality in profits

lies in the differences in the ability of entrepreneurs. Ability is mainly God-gifted.

It is this reason which mainly causes differences in profits.

Demand Analysis

DemandTotal quantity customers are willing and

able to purchase.Demand is the quantity of a good or

service that customers are willing and able to purchase during a specified period under a given set of economic conditions

IMPORTANCE OF DEMAND FOR A FIRMDemand is one of the most important

aspects of managerial economics, since a firm would not be established or survive if a sufficient demand for its product did not exist.

Types of DemandDirect Demand: Individual demand for goods

and services that directly satisfy consumer desires. This is also labelled as consumer demand.

The value or worth of a good or service, its utility, is the prime determinant of direct demand. Individuals are viewed as attempting to maximize the total utility or satisfaction provided by the goods and services they acquire and consume.

Derived Demand: Demand for inputs used in production.

Goods and services are sometimes acquired because they are important inputs in the manufacture and distribution of other products.

The outputs of engineers, production workers, sales staff, managers, lawyers, consultants, office business machines, production facilities and equipment, natural resources, and commercial airplanes are all examples of goods and services demanded not for direct consumption but rather for their use in providing other goods and services.

Determinants of DemandIncomePrices of substitutes Prices of

complements (raw material)

AdvertisingPopulationConsumer

expectations

LAW OF DEMANDLaw of demand states that quantity demanded

of a good is inversely related to its price.When prices of goods goes up, people buy less

and when price goes down, they buy more.Relationship between price and quantity bought

is called demand curve.

Change in Quantity Demanded

Price

Quantity

D0

4 7

10

6

A

A to B: Increase in quantity demanded

B