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# Accounting Profit and Economic Profit

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Suppose you and a friend are thinking about opening a fast-food vending business at a nearby resort during your summer break. This will entail serving pizzas out of a vendor's truck. This is an alternative to working a factory job where you can each earn \$7,000 over the summer break.

A fully equipped truck could be leased for \$9,000. Insurance and other miscellaneous operating expenses will total \$1,000. Given your projected sales revenues of \$33,000, you anticipate your variable costs to total \$8,000. You and your partner have just enough money in the bank to cover all of the summer's fixed and variable costs of the business. If you pull that money out of the bank, then you will collectively forego \$1,500 in interest income for the summer.

1. What would be the accounting profit for your business?

2. What would be the economic profit for your business?

3. Should they go ahead with their plan?

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#### Solution Preview

Suppose you and a friend are thinking about opening a fast-food vending business at a nearby resort during your summer break. This will entail serving pizzas out of a vendor's truck. This is an alternative to working a factory job where you can each earn \$7,000 over the summer break.

A fully equipped ...

#### Solution Summary

Accounting Profit and Economic Profit are determined.

\$2.19

## If the price elasticity of demand for cable TV connections is high and the price elasticity of demand for movies shown in theatres is less than 1, what strategy would you expect cable TV firms to follow in arranging for initial connection?

Please see attached and explain with clear reasoning and use diagrams where appropriate. Thank you.

Question 1:
a) If the price elasticity of demand for cable TV connections is high (for example greater than1.5) and the price elasticity of demand for movies shown in theatres is less than 1, what strategy would you expect cable TV firms to follow in arranging for initial connection?

b) The Stop Decay Company sells an electric toothbrush for \$25. Its sales have averaged 8,000 units per month over the last year. Recently, its closest competitor Decay fighter, reduced the price of its electric toothbrush from \$35 to \$30. As a result, Stop Decay's sales declined by 1,500 units per month.
(i) What is the arc cross price elasticity of demand between Stop decay's toothbrush and Decay fighter's toothbrush?
What does this indicate about the relationship between the two products?
(ii) If Stop decay knows that the arc price elasticity of demand for its toothbrush is -1.5, what price would Stop decay have to charge to sell the same number of units as it did before the Decay fighter price cut? Assume that Decay fighter holds the price of its toothbrush constant at \$30.
(iii) What is Stop Decay's average monthly total revenue from the sale of electric toothbrushes before and after the price change determined in part (ii) ?
(iv) Is the result in part (iii) necessarily desirable? What other factors would have to be taken into consideration?

c) "Because of the Australian love affair with driving motor vehicles, increases in the price of petrol will not affect consumption". What type of demand curve is implied by this statement? Do you believe this is true? Why?.

Question 2
a) Explain the differences between accounting profit, economic profit and normal profit.
b) Suppose that due to changing tastes there is a sudden increase in demand for emu meat
(i) Assuming the costs of emu meat production remain unchanged, what would you expect to happen to profits in the emu meat industry?
(ii) Assuming that there are low barriers to entry into the emu meat industry, explain why resources would move into this industry.
(iii) In the long run, what would you expect to happen to profits in this industry?
(iv) Will normal profits occur in this industry in the long run? If so, explain why.

c) Critically analyse and explain the following statements:
(i) "Wants aren't insatiable. I can prove it. I get all the coffee I want to drink every morning at breakfast"
(ii) "Goods and services are scarce because resources are scarce".

Question 3:
(a) During a five year period, the ticket sales of a city's professional soccer team have increased by 30 percent at the same time that average ticket prices have risen by 50 percent. Do these changes imply an upward sloping demand curve? Explain.
(b) Explain and illustrate graphically the effect of:
(i) An increase in income on the demand curve of an inferior good.
(ii) A drop in the price of product L on the demand for substitute product M.
(iii) A decline in income upon the demand curve of a normal good.
(iv) An increase in the price of product J upon the demand for complementary good K.

(c) If the price of VCR's declines by 20 percent and the total revenue from the sale of VCR's rises, what can you say about the price elasticity of demand for VCR's? Will this price reduction necessarily lead to an increase in profits for the VCR manufacturers?

MACROECONOMICS:

Question 1
(a) Use the aggregate demand - aggregate supply model to explain the consequences in terms of price - level and real output consequences of a decline in aggregate demand as envisioned by:

(i) Classical economics
(ii) Keynesian economics
(iii) Which model you do think is more realistic?
Compare classical and Keynesian interpretations of the aggregate demand curve.
(b) Show the implications of the supply siders' arguments in the aggregate demand- aggregate supply framework. Do you think that tax-transfer disincentives have a short-run or long -run impact or both? Explain.
(c) "Unemployment can be avoided as long as businesses are willing to accept lower product prices, and workers to accept lower wage rates." Critically evaluate this statement.
(d) Explain and evaluate the following statements in terms of Keynesian- monetarist controversy:
(i) "If the national goal is to raise income, it can be achieved only by raising the money supply".
"The size of a government's budget deficit is not important. What is important is how the deficit is financed".

Question 2

(a)Evaluate as accurately as you can the manner in which each of the following individuals would be affected by fairly rapid inflation.
(ii) A department store assistant
(iii) A car assembly line worker
(iv) A heavily indebted farmer
(v) A retired business person whose current income is from interest on government bonds.
(vi) The owner of an independent corner shop

(b)Explain and illustrate
(i) "Policies that stimulate the domestic economy tend to cause a trade deficit"
(ii) "A deficit on the balance on current account will impose severe constraints upon domestic economic policies"
(c )Explain how an increase in aggregate demand that increase real domestic output towards the full employment level may generate instability in the price level. What is this effect referred to us?

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