Question

Chapter 10

1) What is the difference between a normal profit and an economic profit?

2) What is an incentive system?

3) What is the principal-agent problem as applied to corporations? What are the three major ways that corporations can cope with the principal-agent problem?

4) What are the four types of markets? Give a brief description of each type.

5) Describe the conditions under which the monopoly exists. Give two examples.

6) What is the Herfindahl-Hirschman Index and what does it measure?

7) What is the difference between a four-firm concentration ratio and a Herfindahl-Hirschman Index?

Answer 1

Ans) 1) Explicit costs are the direct costs, for eg- wages, cost of machine, cost of raw materials etc.

Implicit costs are basically the opportunity costs or the indirect costs. For eg- the salary of old job that is forgone to start one's own business.

Accounting profit takes into account only explicit cost.

Accounting profit = Total Revenue - Total Explicit Cost.

Economic profit takes into account both implicit and explicit cost.

Economic profit = Total Revenue - (implicit + explicit cost)

Normal profit also includes both implicit and explicit cost. Normal profit is when total revenue is equal to sum of implicit and explicit cost. That is, zero economic profit is normal profit.

2) Incentive system says that people respond to incentives. Incentive is the extra benefit given above the normal benefit. For eg- a bonus for hard work. Incentives push people to work harder. In economics, incentives are mainly financial benefits which motivates workers.

3) Principal agent problem arises when a person (principal) hires someone (agent) to work on his behalf. The problem arises when the agent might not work in the best interest of the principal. For eg- when a shopkeeper hires a worker for the store, the worker might not work in full capacity i.e he might not attend customers properly or may steal something from the shop etc.

It can be dealt in various ways, like÷

• Better monitoring. For eg- installation of security cameras.
• Giving higher wages. As it will increase the opportunity cost for the worker and will give an incentive to work responsibly.
• Delayed payments can also help tackle this problem. If a worker is caught, he will have higher penalty to pay. Eg- bonus at year end.

As per rules and time constraint, only one question is allowed. However, I have answered first three. Kindly ask other questions separately. Thank you.