Profit, Oligopolies and Cartels - Assignment Example

For businesses accounting profit is the way a firm will determine whether it is profitable or not. In order to calculate accounting profit a person must take total sales revenues and deduct all costs incurred, not including the cost of equity capital. On the other for hand, economic profit equals total sales revenue minus total costs including the opportunity costs of equity capital (Wallace). Opportunity costs take into consideration how any of the firms resources used in this project could have been used differently and how foregoing an alternative investment or project affects the overall firm's profit margin.

The difference between accounting and economic profit lies in the opportunity costs. Simply stated, economic profit takes into consideration how opportunity costs affects the real total economic value of a firm taking into consideration all possible alternative uses of those assets (Khanacademy). 2) A cartel is a collection of businesses, countries or organizations which provide a good or service which create an organization through a formal agreement in order to regulate the supply of such product or service in order to manipulate or regulate prices and limit competition (Investopedia).

When a market is cornered by a cartel the members will collude in order to limit total output of their products. The purpose of this exercise is to maintain production below actual demand, consequently raising market price and increasing their profit margins. Oligopolies distinguish themselves from a cartel in an economic market where there is a lot of competition, but a few large firms dominate an industry where economic market conditions favor large enterprises. The firms compete based on price, product differentiation, brand and customer service (Diffen).

Oligopolies can quickly become a cartel if lack of oversight or regulation allows them to mutually collude to manipulate market prices, limit supply and squeeze out the competition therefore becoming a de facto cartel. 4) An oligopoly can be defined as an economic market in which a limited number of companies participate (Investopedia). Due to the fact that a small number of companies participate interdependence exists. The existence of interdependence implies that firms must take into account the likely reactions of other firms in the market when making investment and pricing decisions (Tutor2u).

An example of an oligopoly market is the airline industry. Airlines are constantly changing their prices and offers based on the actions of the competition. Differentiation does not exist in an oligopoly because all firms sell similar products. Interdependence causes companies to constantly monitor the actions of other participants in the market. The competition for price and profits in an oligopoly due to interdependence cannot get out of control because all firms lose when a price war occurs. 6) By design monopolies are inefficient compared with a competitive industry.

In a competitive industry firms operate at a level where price equals marginal cost. Therefore a monopoly will operate where price will also be higher than a competitive firm and consequently production output will be lower than the point of maximum efficiency. Although a monopoly just like a competitive firm should produce additional units of output until marginal revenue equals marginal cost in order to maximize firm profit, by design they don't (Econweb). Simply stated a monopoly operates at an inefficient output level.

A monopolistic firm will limit and maintain a level of production which allows them to maximize their unit selling price at the expense of the consumer. Where a competitive firm will strive for an efficient level of output by comparing whether producing an additional unit of output just equals the costs, the monopolist will not use the same basis. A monopolistic firm will look at what the effect of how producing an additional unit of output will affect the sale price of all the previously manufactured products (Varian).

Typically a monopoly will produce an additional unit of output as long as it does not affect the price of all previously manufactured units. 8) In a purely competitive market a firm only has to worry about its own level of production where all firms are producing an identical product and market price is independent from their own level of output (Businessdictionary). The main characteristics of perfect competition are (Economicsconcepts): Large number of competing firms in an industry where no one firm is big enough to exercise influence in the market price.

Large number of buyers where no individual buyer can affect the purchase price due to volumes. There is no real physical difference between the products offered by all the competitors, the product is perfectly homogeneous. No barriers of entry for new firms to enter the market. There is no information discrepancy between consumers and producers. They both have perfect information regarding prices, costs and market conditions. Profit maximization Work Cited Page Businessdictionary.com. “Perfect Competition.

” 1 December 2013. Diffen.com. 2013. “Cartel vs Oligopoly.” 30 November 2013. Economicsconcepts.com. 2012. “Perfect Competition.” 1 December 2013. Econweb.com. 2005. “Monopoly – Profit Maximization.” 30 November 2013. Investopedia.com. 2013. “Cartel.” 30 November 2013. Investopedia.com. 2013. “Oligopoly.” 30 November 2013. Khanacademy.org. 2013. Economic profit vs accounting profit. 30 November 2013. Tutor2u.net. 2013. “Oligopoly.” 30 November 2013. Varian, H.

Intermediate Microeconomics: A Modern Approach. London: W.W. Norton & Company. 2003. Print. Wallace, M. 2013. Accounting Profit vs. Economic Profit Assets. 30 November 2013.