Chapter 7 (ECONOMIC PROFITS AND LOSSES)

Question 1

Depreciation

Answer 1

Decrease in the vale of equipment overtime because of wear and tear because it becomes old or unnecessary

Question 2

Explicit costs

Answer 2

• otherwise known as obvious costs
• costs a business pays directly… spending money
• accounts count all obvious business costs and include depreciation
• allowable yearly depreciation cost is the price of equipment divided by number of years it lasts
• ex: wages, rent, resources

Question 3

Accounting profits

Answer 3

• revenues minus explicit costs (including depreciation)

Question 4

Implicit costs

Answer 4

• hidden opportunity costs of what business owner could earn elsewhere with time and money invested (non-monetary/ not related to $)
• opp cost of TIME… best alternative use of business owner’s time
• opp cost of MONEY… best alternative use of business owner’s money invested in the business must include compensation for risk
• ex: salary, interest

Question 5

Risk averse

Answer 5

• someone who avoids risk… investor requires a high compensation for taking risks

Question 6

Risk loving

Answer 6

• investor does not require much compensation for taking risks

Question 7

Normal profits

Answer 7

• sum of hidden opportunity costs (implicit costs)
• compensation for business owner’s time and money
• what business owner must earn to do as well as best alternative use of time and money
• a average profits in other industries

Question 8

Economic profits

Answer 8

• revenues minus ALL OPPORTUNITY COSTS
• key difference between economists and accountants is that economists subtract hidden opportunity costs when calculating profits
• economic profits < accounting profits
• the owner’s residual claim on the income of the business
• green light: business expand and enter industry, supply increases, pushing prices down, until prices just cover all opp costs of production and economic profits are 0

Question 9

Economic Losses

Answer 9

• negative economic profits
• if revenues are less than all opp costs, business owner has not made a smart decision and would be better off in alt. use of time and money
• with economic losses, business owner is earning less than normal profits, less than average profits in other industries
• red light: businesses leave industry, supply decreases, pushing prices up until prices just cover all opp cost of production and economic profits are 0

Question 10

Break even point

Answer 10

• yellow light: businesses just earning normal profits. Market equilibrium with 0 economic profits or losses. No tendency for change

Question 11

Short run market equilibrium

Answer 11

• quantity demanded = quantity supplied
• but economic losses or profits lead to changes in supply
• time period where at least one cost is FIXED
• ex: factory size, salaried employees

Question 12

Long run market equilibrium

Answer 12

• Qd= Qs… economic profits are 0, no tendency for change
• the price consumers are willing and able to pay just covers businesses opp costs of production, including normal profits
• the time period where all costs are VARIABLE
• ex: change factory size, fire salaried employees