Chapter 7: Efficiency, Exchange, and the Invisible Hand in Action I. The Invisible Hand a. Individuals act in their own interests i. Aggregate outcome is collective well-being b. Profit motive ii. Produces highly valued goods and services iii. Allocates resources to their highest value use 1. Jon Stewart does not wait tables II. Accounting Profit c. Most common profit idea d. Accounting profit = total revenue – explicit costs iv. Explicit costs are payments firms make to purchase v. Resources (labor, land, etc.) and vi. Products from other firms e. Easy to compute f. Easy to compare across firms III. Economic Profit g. Economic profit is the difference between a firm's total revenue and the sum of its explicit and implicit costs vii. Also called excess profits h. Implicit costs are the opportunity costs of the resources supplied by the firm's owners i. Normal profit is the difference between accounting profit and economic profit viii. Normal profits keep the resources in their current use IV. Three Kinds of Profit j. Two Functions of Price ix. Rationing function of price distributes scarce goods to the consumers who value them most highly x. Allocative function of price directs resources away from overcrowded markets to markets that are underserved xi. Invisible Hand Theory states that the actions of independent, self-interested buyers and sellers will often result in the most efficient allocation of resources 2. Articulated by Adam Smith in eighteenth century V. Responses to Profits and Losses k. Will the firm remain in business in the long run? xii. If it covers ALL of its costs l. Firms that earn normal profit recover only their opportunity cost