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” 3 “If everyone can do it. it’s difficult to create and capture value from it. k t no firm realizes economic profits (rents).“If everyone can do it. it’s difficult to create and capture value from it.” or.” 4 2 . alternatively “In a perfectly “I f tl competitive titi market.

956 All data in US $ millions from 1998..e.328 $2. 1999. Accounting Profits Economic Profits 5 Tobin’s Q • Ratio of a firm’s market value to its asset replacement value • Directly measures “rents” above those to physical inputs • Difficult to calculate because it requires knowledge of assets’ replacement value Discounted Cash Flow (DCF) g forward • Measures value of firm g going • Discount rate reflects return to equity (i. Oxford University Press. “Modern Competitive Analysis”.def.541 Microsoft $4. Abstracted from S. opportunity cost) • Positive NPV indicates rents over and above returns to all inputs 6 3 .525) General Motors $2. economic profits (rents) are returns in excess of what an investor expects to earn from investments of similar risk (i.. in excess of the opportunity cost of capital) IBM $6.e.490 $4 490 $3. Oster.776 $(5.

no firm realizes economic profits (rents).“In a perfectly competitive market. 7 An Industry S1 D 8 4 . The strategists task is to identify ways in which firms may capitalize on these market imperfections.” The existence of economic profits suggests some type of market inefficiency.

An Industry S1 P1 D Q1 9 An Industry S1 P1 D Q1 P1 A Firm MC AC 10 5 .

c(q1) – cf )/δq1 = 0 c’(q (q1) = 0 P1 – c P1 = c’(q1) = MC 12 6 .c(q1) – cf δπ/δq1 = δ(P1q1 .An Industry S1 P1 D Q1 P1 A Firm MC AC q1 11 Profits = Revenues – Variable Costs – Fixed Costs π= P1q1 .

An Industry S1 P1 D Q1 P1 A Firm MC AC 13 An Industry S1 P1 D Q1 P1 A Firm MC AC q1 14 7 .

An Industry S1 P1 D Q1 P1 A Firm MC AC q1 15 An Industry S1 P1 D Q1 P1 A Firm MC AC q1 16 8 .

An Industry S1 P1 P2 D Q1 Q2 S2 P1 A Firm MC AC q1 17 An Industry S1 P1 P2 D Q1 Q2 S2 P1 P2 A Firm MC AC q2 q1 18 9 .

no firm realizes economic profits (rents).” The existence of economic profits suggests some type of market inefficiency. The strategists task is to identify ways in which firms may capitalize on these market imperfections.An Industry S1 P1 P2 D Q1 Q2 S2 P1 P2 A Firm MC AC q2 q1 19 “In a perfectly competitive market. 20 10 .

Density Returns 21 “ When you are presented with a project that appears to have a positive NPV. • Returns for individual companies vary over time. They may reflect simple estimation errors in forecasting cash flows. Facts: risk • Average industry returns vary even after controlling for risk.” From the chapter. “Where Positive Net Value Comes From” Brealey & Myers. Probe behind cash flow estimates and try to identify the source of economic rents. don’t just accept the calculations at face value. • Returns among companies within industries vary even more. Principles of Corporate Finance 22 11 . A positive NPV for a new project is believable only if you believe that the company has some special advantage.

(Industrial Organization View) Monopoly Rents (Resource Based View) Ricardian Rents Schumpeterian Rents (Dynamic ( y Capabilities p View) ) S P S’ MC 1MC 2 P AC 1 q1 q2 AC 2 D Q -Barriers to entry -Industry structure matters -Barriers to imitation -Firm structure matters -Markets are dynamic -Innovation matters (Industrial Organization View) Monopoly Rents S P S’ D Q -Barriers to entry -Industry structure matters 12 .

(Resource Based View) Ricardian Rents MC 1MC 2 P AC 2 AC 1 q1 q2 -Barriers to imitation -Firm structure matters Schumpeterian Rents (Dynamic Capabilities View) -Markets are dynamic -Innovation matters 13 .

Broadly firms may capture economic B dl speaking. fit markets. product markets are rarely perfect and firms often have competitive advantage. 27 14 . realizes economic Economic profits are returns in excess of the opportunity cost of capital.In perfectly competitive k t no firm fi li i profits. ki fi t i profits fit when there are either barriers to competition or barriers to imitation. In the real world. The Fundamental Principle -.

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