S. Klepper, Economics 73-100

• Owner manages own company, takes no salary

• Stockholders provide $ to finance firm’s fixed investment

• No payment promised them

• Inputs in inventory—purchase price ¹ current price

• Accounting costs = outlays

• Obviates judgments—e.g., value of owner-manager’s services

• Economic costs = opportunity costs

• Salary of manager-owner if worked elsewhere

• Stockholders—return on comparably risky investment

• Inventoried input—current price

Profits = Total Revenues – Total Costs: Accounting vs. Economic Profits

• Economic profits

• Total costs = Total sacrifice = Total revenues if used inputs for other purposes

• Zero economic profits: Doing as well as elsewhere

• Nonzero economic profits a signal for change

• Accounting profits

• No cost to $ raised from stockholders

• Economic profit = 0 ® Accounting profit = total return on comparably risky investment > 0
• Accounting Profit/Invested Capital = % Return on comparably risky investment

• Economic profit > 0 ® Accounting Profit/Invested Capital > % Return on comparably risky investment

• Economic profit < 0 ® Accounting Profit/Invested Capital < % Return on comparably risky investment

• Collusion to reap high profits

• What are high profits?

• Huge total profits?

• Accounting Profits/Invested Capital > % Return on comparably risky investment

• Pre-OPEC return on investment vs. Manufacturing average return on investment