Chapter 6.docx

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Paul Cohen

Chapter 6: Finding the Bottom Line (Opportunity costs, economic profits and losses, and the Miracle of Markets) Accounting Profits = Revenues – Obvious costs (including deprecation) Depreciation: Tax rule for spreading cost over lifetime of long-lasting equipment. -Deprecation also means decrease in value because of wears and tears and because equipment becomes obsolete. Obvious costs: Costs a business pays directly Accounting profit: Revenues minus obvious costs (including deprecation). Implicit Costs: Hidden opportunity costs of what business owners could earn elsewhere with time and money invested -Wahid’s hidden opportunity cost (implicit cost) of investing his own 30’000 in his risky business is 20 percent expected return, on $6000—Sum of guaranteed bank return of 5 percent plus risk compensation of 15%. Normal Profits: Compensation for business owner’s time and money, sum of hidden opportunity costs (implicit costs), what business owner must earn to do as well as best alternative use of time and money. Economic Profits: Revenues minus all opportunity costs (obvious costs plus hidden opportunity costs). Economic Profits = Revenues – All opportunity costs = Revenues – (Obvious Costs + Hidden Opportunity c
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