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MEASURING ECONOMIC PROFIT

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by

Todd Cota

on 4 December 2013

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Transcript of MEASURING ECONOMIC PROFIT

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.
ACCOUNTING 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
Normal 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.
ECONOMIC PROFIT:
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)
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