Optimization as Rationality

It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. Given this assumption, there are four categories in which a firm's profit may be considered.
The Graph – 3 depicts the situations that could be faced by entrepreneurs:

- Situation one: Between the Price 1 and Price 2 lines; a firm is said to be making an economic profit when its average total cost is less than the market price (price 2) of the product, at the profit-maximizing output.
These abnormal economic profits are equals to the quantity output multiplied by the difference between the average total cost and the market price, this is known as extra-profit or surplus, and depict the power of the firm to determine price in such industry.

- Situation two: Over the Price 2 line; a firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profit-maximizing output.

In economics a “normal profit rate” is understood as the general rate of profits earned in the whole industry for any single enterprise.
In addition Graph – 3, depicts the profit-maximizing output, as the equilibrium point, where Marginal cost equals Total average cost, and equals the price level (price 2). Over this point the single enterprise tend to gain monopolistic surplus. The microeconomic model assume this situation as a temporal disturbance, which, is adjusted under competitiveness conditions when more entrepreneurs are enticed for the big profits, arising more enterprises in that industry, increasing the supply of goods and pressing down the price to the normal profit point.
Despite the last consideration, in real life there exist natural and/or artificial barriers to entry in the market, in consequence the monopolistic or oligopolistic trend in the market tend to remain for ever, unless the government and the policy makers interfere the market conditions until the structure of this market back to the desired conditions. At this point the governor and policy makers act as an special agent, maximizing the social-welfare.
If monopoly or oligopoly are convenient structures for the society is an “opened debate”, but in general this two structures are inefficient for customers because as can be seen in graph – 3; the price is bigger than the competitiveness price, therefore the consumer surplus decrease.

- Situation three: Between price 1 and price 3 lines, this gap is depicted by the average total cost and by average variable cost at the profit-maximizing output, then the firm is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss would be larger if it was to stop producing.
By continuing production, the firm can offset its variable cost and at least part of its fixed cost, but by stopping completely it would lose equivalent of its entire fixed cost.


- Situation four: If the price is below average variable cost at the profit-maximizing output, depicted under de price – 3 line, in the correspondent graph: The firm is said to be in shutdown. Losses are minimized by not producing at all, since any production would not generate returns significant enough to offset any fixed cost and part of the variable cost. By not producing, the firm losses only its fixed cost.
The depicted dynamic enterpriser’s movements shape the business cycle as en evolutionary structure in which the market competence rules, push up the innovative and technological dexterities for managers, researchers, and share holders, in order to survive in the market; a place where only the most adapted survive for the long wave in the same manner as the natural evolution in which all species fight among them to survive over the time in places restricted by the resource’s scarcity and under changing environmental conditions.

Coming back to the idea about the market imperfections is possible to set up that in economics, a market failure is a situation in which markets do not efficiently organize production or allocate goods and services to consumers (for example, a failure to allocate goods in a way some see as socially or morally preferable). To economists, the term would normally be applied to situations where the inefficiency is particularly dramatic, or when it is suggested that non-market institutions would provide a more desirable result.

On the other hand, to many, market failures are situations where market forces do not serve the perceived "public interest". Here, the focus is on the economists' theories of market failure.
Economists use model-like theorems to explain or understand such cases. The two main reasons that markets fail are:

- The inadequate expression of costs or benefits in prices and thus into microeconomic decision-making in markets.
- Sub-optimal market structures: In economics, information asymmetry
occurs when one party (seller or customer) to a transaction has more or better information than the other party. (It has also been called asymmetrical information and markets with asymmetrical information). Typically it is the seller that knows more about the product than the buyer, however, it is possible for the reverse to be true: for the buyer to know more than the seller.

Examples of situations where the seller usually has better information than the buyer are numerous but include used-car salespeople, stockbrokers, real estate agents, and life insurance transactions.
Examples of situations where the buyer usually has better information than the seller include estate sales as specified in a last will and testament, and the labour market.

This situation was first described by Kenneth J. Arrow in a seminal article on health care in 1963 entitled "Uncertainty and the Welfare Economics of Medical Care," in the American Economic Review.

George Akerlof later used the term asymmetric information in his 1970 work The Market for Lemons. He also noticed that, in such a market, the average value of the commodity tends to go down, even for those of perfectly good quality. It is even possible for the market to decay to the point of nonexistence.
Because of information asymmetry, unscrupulous sellers can "spoof" items (like software, second-hand cars, or computer games) and defraud the buyer. As a result, many people not willing to risk getting ripped off, will avoid certain types of purchases, or will not spend as much for a given item.