R15 Demand and Supply Analysis The Firm
CFA® Level I – Economics
Demand and Supply Analysis: The Firm www.irfanullah.co Graphs, charts, tables, examples, and figures are copyright 2012, CFA Institute.
Reproduced and republished with permission from CFA Institute. All rights reserved.
1
Contents and Introduction
1. Introduction
2. Objectives of the Firm
3. Analysis of Revenue, Costs and Profits
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2
2. Objectives of the Firm
• The objective of the firm should be to maximize shareholder value
• This reading assumes that the objective of the firm is to maximize profit over the period ahead and that prices/quantities are know with certainty
• But, what is the definition of profit? It depends on who you ask!
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3
2.1 Types of Profit Measures
• Accounting Profit
Net income on a company’s financial statements
Accounting profit = Total revenue – Total accounting costs
• Economic Profit
Also known as abnormal or supernormal profit
Economic profit = Accounting profit – Total implicit opportunity costs
Economic profit = Total revenue – Total economic costs
• Normal Profit
Accounting profit a firm must earn in order to cover implicit opportunity costs ignored in accounting costs
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4
Example
Startup Company
Publicly Traded Company
Accounting Profit
Salary Cut
Ret on 1.5 mil investment
=
=
=
300,000
100,000
200,000
Economic Profit
=
0
Cost of Equity is the implicit cost
Equity investment is 18.75 mil and investors require an 8% return Accounting profit = 2 mil
Earning ‘Normal Profit’
Accounting profit just covers implicit opportunity costs
Economic profit = 0.5 mil
Normal profit = 1.5 mil
www.irfanullah.co
5
Economic Rent
P
Economic rent refers to payment to a factor of production in excess of opportunity cost
S
Economic rent results when a particular resource or good is fixed in supply (with a vertical supply curve) and market price is higher than what is required to bring the resource or good onto the market and sustain its
Demand and Supply Analysis: The Firm www.irfanullah.co Graphs, charts, tables, examples, and figures are copyright 2012, CFA Institute.
Reproduced and republished with permission from CFA Institute. All rights reserved.
1
Contents and Introduction
1. Introduction
2. Objectives of the Firm
3. Analysis of Revenue, Costs and Profits
www.irfanullah.co
2
2. Objectives of the Firm
• The objective of the firm should be to maximize shareholder value
• This reading assumes that the objective of the firm is to maximize profit over the period ahead and that prices/quantities are know with certainty
• But, what is the definition of profit? It depends on who you ask!
www.irfanullah.co
3
2.1 Types of Profit Measures
• Accounting Profit
Net income on a company’s financial statements
Accounting profit = Total revenue – Total accounting costs
• Economic Profit
Also known as abnormal or supernormal profit
Economic profit = Accounting profit – Total implicit opportunity costs
Economic profit = Total revenue – Total economic costs
• Normal Profit
Accounting profit a firm must earn in order to cover implicit opportunity costs ignored in accounting costs
www.irfanullah.co
4
Example
Startup Company
Publicly Traded Company
Accounting Profit
Salary Cut
Ret on 1.5 mil investment
=
=
=
300,000
100,000
200,000
Economic Profit
=
0
Cost of Equity is the implicit cost
Equity investment is 18.75 mil and investors require an 8% return Accounting profit = 2 mil
Earning ‘Normal Profit’
Accounting profit just covers implicit opportunity costs
Economic profit = 0.5 mil
Normal profit = 1.5 mil
www.irfanullah.co
5
Economic Rent
P
Economic rent refers to payment to a factor of production in excess of opportunity cost
S
Economic rent results when a particular resource or good is fixed in supply (with a vertical supply curve) and market price is higher than what is required to bring the resource or good onto the market and sustain its