ECO105 Ch. 7: Opportunity cost, economic profile/losses, miracle of markets

Bottom line 純利

The profit that remains after subract all cost from revenues

Explicit cost (Obvious cost)

- Cots a business pays directly
- Eg. Rents

Depreciation

- decrease in the value of equipment over time
- because of wear and tear, will becomes obsolete 過時

Implicit

Hidden opportunity costs (Time and money) of what business owner could earn elsewhere with time and money invested.

Risk premium

higher rate of return you can expect to earn from risker assets

Risk loving

- Risk taker
- Investor does not require much compensation for taking risks

Risk averse

- Risk avoiding
- investor requires high compensation for taking risks

Normal Profit

1) Compensation for business owner's time and money
2) Implicit cost (Sum of hidden opportunity cost)
3) What business owner must earn to do as well as best alternative use of money and time
4) Average profits in other industries

Accounting Profits

- Revenues - obvious cost (Include depreciation)
- Does not subtract hidden opportunity cost

Economic Profits

- Less than accounting profits
- Subtract hidden opportunity cost
- Revenues minus ALL opportunity cost
1) Revenues - (Obvious Cost + Hidden opportunity cost)
2) Revenues - (Obvious Cost + Implicit cost)
3) Revenues - (Obvious Cost + Normal Profit)

Negative economic profits; Red light

- Economic losses
- If revenue < all opportunity cost, not a smart decision
- Business owner earn less than normal profits or less than average profits in other industries
- Business should leave industry
- Supply decreases, price goes up until just cover opportunity cost of production
- Economic profit = zero

Zero Economic profit; Yellow light

- Breakeven point
- Businesses just earning normal profits
- Market equilibrium with zero economics profits/losses
- No tendency for change

Positive Economics profit; Green light

- Business expand and enter industry
- Supply increases, pushing price down until prices just cover all opportunity cost of production
- economic profits = zero

Short run market equilibrium

- Quantity demanded = quantity supply
- but economic losses or profits lead to change in supply

Long run market equilibrium

- Quantity demanded = quantity supply
- Economic profits = 0
- No tendency to change

Difference between SR & LR market equilibrium

- Additional time it takes for supply changes to adjust economic profit zero

Changes in economic profits triggers:

1) Changes in supply
2) Changes in price
3) Moving industry from short-run to long-run market equilibrium
- Key signals directing businesses to product products and services consumers want