What does a zero economicprofit mean?
We would frame the world through markets.You have both supply and demand in a market.The intersection is where price and quantity are set if the market is competitive.
For an efficient market with perfect competition, long run economic profits are zero.
It didn't make sense to me when I first learned it.If you were confused by it, you would be told that economic profits are different from accounting profits.Accounting profits are the profits we usually think of.Economic profits were different because they were dealing with the opportunity costs as well as the actual costs.
This didn't seem to clarify things.I didn't fully understand what was meant by this as I continued with my economics degree.
Investment money is needed to cover costs.You will need to purchase things in the store.I don't know how much it would cost to start this, but suppose you decide to use $70,000 of your own savings.
There is an opportunity cost to that investment.You could have used that $70,000 as a down payment on a house.You could have put that into the stock market.Either of these could have been used to start your business, instead of making a return on investment.
The average return on investment of your other options is what we are talking about.8% is what it would be.
To cover the opportunity cost of starting a coffeeshop, you need a profit of at least 8%.
Suppose the coffeeshop opens.There are a lot of people coming in to order coffee.You will need employees to help when you begin by yourself.
The opportunity cost in hiring each employee is the same as when investing in the business initially.The minimum wage is $9 an hour.
You could use the money to go somewhere else.You could use that for local advertising.You wouldn't hire workers if you could make more money using it.The opportunity cost of not hiring an employee is higher than the other options because you realize that you need the employees in order to provide service to the increasing number of customers.
If you find two workers who are willing to accept minimum wage for their labor, this suggests that they will be making a higher return on their time investment in working for you than they could make elsewhere.For instance, suppose that another business was hiring at the same rate.They would face a higher opportunity cost if they didn't work for your competitor and instead worked for you.
The wage rate covers the opportunity cost for both the worker and the employer.
Like for your employees, there is an opportunity cost for managing and operating the coffeeshop.You will make 8% to cover the opportunity cost of your investment.This only covers the opportunity cost of the capital, but does not cover the effort and risk you take.It doesn't take much to start a business, even if you put money in the stock market.
If you manage the coffeeshop you can use the time to work for someone else and make money.Expect to make a higher return when you start your own business because you will be putting in far more hours.You expect to make a higher return on your investment because of the risk that your business will fail.
For someone starting a coffeeshop, they expect to make an extra 7% return on investment for their effort and risk, above the 8% cost of placing their money elsewhere.
We evaluate the revenues and costs of the coffeeshop over time.
To cover the cost of labor, you have to pay labor costs.You can cover the opportunity cost of capital by paying off expenses related to the storefront or machinery.After covering these costs, you have accounting profits that remain.
In a perfectly competitive market, we would expect the profits to provide a 15% return on investment for you.If you placed your money elsewhere, you could have generated an 8% return.The opportunity cost associated with the risk and effort you put into the business is covered by the additional 7% return.
You don't earn excess profits greater than the opportunity costs you face if you make money.Economic profits are zero.
Because each resource is being used to maximize their opportunity cost, we would say that they have been allocated efficiently.Resources are being used to their best advantage.