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Lecture 7

ECO105Y1 Lecture Notes - Lecture 7: Moving Company, Risk Compensation, Economic Equilibrium


Department
Economics
Course Code
ECO105Y1
Professor
Avi Cohen
Lecture
7

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The Three Keys Model to Smart Choices
·Choose only when additional benefits are greater than additional
opportunity costs
·Count only additional benefits and additional opportunity costs
·Be sure to count all additional benefits and costs, including implic
it costs and externalities
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The Three Keys Model to Smart Choices
·Choose only when additional benefits are greater than additional
opportunity costs
·Count only additional benefits and additional opportunity costs
·Be sure to count all additional benefits and costs, including implic
it costs and externalities
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The Three Keys Model to Smart Choices
·Choose only when additional benefits are greater than additional
opportunity costs
·Count only additional benefits and additional opportunity costs
·Be sure to count all additional benefits and costs, including implic
it costs and externalities
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5ACCOUNTING PROFITS AND
HIDDEN OPPORTUNITY COSTS
Accounting profits equal revenues minus all obvious costs, including
depreciation. But accounting profits miss the hidden, implicit oppor
tunity costs of a business owner’s time and money.
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·Obvious costs (explicit costs)
costs a business pays directly
·Accountants count all obvious business costs and
include depreciation
·Decrease in the value of equipment over time because of wear and tea
r and because it becomes obsolete
·Yearly depreciation cost is the price of equipment divided by number
of years it lasts
·Accounting profits
Revenues – Obvious Costs (including depreciation)
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7Accountant’s One-Year Business Plan
for Wahid’s Web Wonders
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·Implicit costs
hidden opportunity costs of what business owner could earn elsewher
e with time and money invested
·Opportunity cost of time —
best alternative use of business owner’s time
·Opportunity cost of money —
best alternative use of business owner’s money invested in the bus
iness
·Must include compensation for risk
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·Risk compensation depends on attitudes toward risk
·Risk-loving investor does not require much compensation for taking r
isks
·Risk-averse (risk-avoiding) investor requires
high compensation for taking risks
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12 NORMAL PROFITS AND ECONOMIC PROFITS
Smart business decisions return at least normal profits — what a bu
siness owner could earn from the best alternative uses of her time a
nd money. There are economic profits over and above normal profits
when revenues are greater than all opportunity costs of production,
including hidden opportunity costs.
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