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(a) Explain and illustrate the roles played by profit in allocating scarce resources within the economy over time. [10m] Profit being a form of return from risk-taking and entrepreneurship, plays a significant role in allocating limited factors of production (land, capital, entrepreneur, labour) in the economy over time. It acts as a signaling mechanism in the free market system and funds capital investment so as to generate more returns in the future. Furthermore, it serve as an indicator to producers on what and how much to produce, how to produce and for whom to produce. This allows them to allocate scarce resources effectively and hence, maximize profits. Traditionally, the objective of every firm is to maximize their profit. This can be done by producing at the output level where marginal revenue=marginal cost (MR=MC). At this point, the additional revenue that a firm would earn by selling one more unit of good would be equivalent to the additional cost required to produce it. Hence, firms would allocate their resources to increase output till this point as reflected in the diagram A.


For example, Apple Company uses supernormal profits earned from selling its products for research and development such as improving of IPhone 3 to IPhone 4. Hence, this would allow better allocation of scarce resources and allow firms to achieve dynamic efficiency. Profits also serve as a signaling mechanism in the free market system. In economy, some good may generate subnormal profits while others may generate supernormal profits. When faced with such situation, firms in the economy could shift their resources from producing the subnormal profits goods to producing the supernormal profits goods. This is because these firms hope to acquire the highest rate of returns. For example, in the disk industry, consumers' preferences have changed from VCDs to DVDs and Blu-ray due to the higher definition and greater...

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