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MEASURING ECONOMIC PROFIT
Transcript of MEASURING ECONOMIC PROFIT
WHAT IS THE ROLE OF ECONOMIC PROFIT IN THE ALLOCATION OF RESOURCES?
Economic profit allocates resources. It is a signal indicating whether resources would have a higher value in another use. When economic profit is negative, resources flow elsewhere; when it is positive, resources flow to the activity creating the profit.
NET OPERATING INCOME (PQ - COST OF LAND - COST OF LABOR - COST OF CAPITAL
A company's total earnings, calculated according to Generally Accepted Accounting Principles (GAAP), and includes the explicit costs of doing business.
TWO MEASURES OF PROFIT
The accounting profit that occurs when economic profit is zero.
Zero Economic Profit:
Total revenue equals total costs, including opportunity costs.
Negative Economic Profit:
Resources used have a higher value elsewhere. When total revenue does not pay for all costs, including the opportunity costs
Positive Economic Profit (Abnormal Economic Profit):
Total revenue exceeds total costs, including opportunity costs.
The difference between the total revenue and the cost of all inputs used by a firm over a given period. It is the TR - Economic Costs (Opportunity Costs). OC are the explicit and implicit costs of the best alternative actions forgone.
Total Profit = Total Revenue - Economic costs (explicit & implicit)