This document discusses several theories of profit, including the frictional theory, monopoly theory, compensatory theory, and innovation theory. It also covers demand analysis, defining demand, the importance of demand for firms, types of demand including direct and derived demand. The determinants of demand and the law of demand are explained. In summary, the document outlines different theories for why firms earn profits and provides an overview of demand analysis concepts.

2. 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)

3. 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.

4. 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.

5. 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.

6. 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.

7.  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

8. Innovations may be of two types
1. 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.

9. 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.

10. Demand Analysis

11. Demand
 Total 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

12. IMPORTANCE OF DEMAND FOR A FIRM
 Demand 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.

13. Types of Demand
 Direct 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.

14.  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.

15. Determinants of Demand
 Income
 Prices of substitutes
 Prices of
complements (raw
material)
 Advertising
 Population
 Consumer
expectations

16. LAW OF DEMAND
 Law 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.

17. Change in Quantity Demanded
Price
Quantity
D0
4 7
10
6
A
A to B: Increase in quantity
demanded
B