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Lecture 7

HIS109Y1 Lecture Notes - Lecture 7: Moving Company, Economic Equilibrium, Opportunity Cost

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Kenneth Bartlett

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ECO105: November 16th
Opportunity costs, economic profits/losses, miracle of markets
Accounting profits equal revenues minus all obvious costs, including depreciation. But accounting profits miss
the hidde, ipliit opportuity osts of a usiess oer’s tie ad oey.
Obvious Costs (explicit costs):
o Costs a business pays directly. (Hydro bill, insurance)
o Accountants count all obvious business costs and include depreciation.
Decrease in the value of equipment over time because of wear and tear and because it
becomes obsolete.
Yearly depreciation cost is the price of equipment divided by number of years it lasts.
Accounting Profits:
o Revenues Obvious Costs (including depreciation).
Aoutat’s Oe Year Busiess Pla for Wahlid’s We Woders (Fig. 7.1):
Implicit Costs:
o Hidden opportunity costs of what business owner could earn elsewhere with time and money
o Opportunity cost of time est alteratie use of usiess oer’s tie.
o Opportunity cost of money est alteratie use of usiess oer’s oey iested i the
o Most include compensation for risk.
o Risk compensation depends on attitudes toward risk.
Risk-loving investor does not require much compensation for taking risks.
Risk-averse (risk-avoiding) investors require high compensation for taking risks.
Normal Profits and Economic Profits:
Smart business decisions return at least normal profits what a business owner could earn from the best
alternative uses of her time money. There are economic profits over and above normal profits when revenues
are greater than all opportunity costs of production, including hidden opportunity costs.
Normal Profits:
o Copesatio for usiess oer’s tie ad oey, or
o Sum of hidden opportunity costs (implicit costs), or
o What business owner must earn to do as well as best alternative use of time and money, or
o Average profits in other industries.
Economic Profits =
o Revenues minus all Opportunity Costs.
o Revenues (Obvious Costs + Hidden Opportunity Costs).
o Revenues (Obvious Costs + Implicit Costs).
o Revenues (Obvious Costs + Normal Profits).
o Economists subtract hidden opportunity costs when calculating profits
Economic profits are less than accounting profits.
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