Wealth - is created when assets move from lower- to
higher-valued uses.
Opportunity costs arise due to RESOURCE SCARCITY
Efficiency implies opportunity NEVER
When economists speak of "marginal," they mean
INCREMENTAL
If a firm's average cost is rising, then marginal cost is
greater than average cost.
A decrease in the price level will increase the breakeven
quantity
The higher the interest rates the more value individuals
place on current dollars; the fewer investments will take
place.
Individual’s value for a good or service - is measured as
the amount of money he or she is willing to pay for it.
To “value” a good - means that you want it and can pay for
it
Capitalism - creates wealth by letting a person follow his or
her self-interest.
Voluntary transactions - create wealth.
Seller surplus - the difference between the agreed-on price
and the seller’s value.
Buyer surplus - is the buyer’s value minus the price.
Total surplus or gains from trade - is the sum of buyer and
seller surplus; the difference between the buyer’s top dollar
and the seller’s bottom line.
Governments - play a critical role in the wealth-creating
process by enforcing property rights and contracts—legal
mechanisms that facilitate voluntary transactions.
An economy is efficient - if all assets are employed in their
highest-valued uses.
Henry Hazlitt - former editorial page editor of the Wall
Street Journal, “The art of economics consists in looking not
merely at the immediate but at the longer effects of any act or
policy; it consists of tracing the consequences of that policy
not merely for one group but for all groups.”
The one lesson of business: The art of business consists of
identifying assets in low-
valued uses and devising ways to profitably move them to
higher-valued ones.
Impedes the movement of assets to higher-valued uses;
Such inefficiency implies a money-making
opportunity:
Taxes - The government collects this out of the total
surplus created by a transaction.
Subsidies - The opposite of a tax.
Price control - is a regulation that allows trade only at
certain prices.
Price Ceiling - protect consumers; it is binding when the
equivalent of an implicit tax on producers and an implicit
subsidy to consumers.
Price Floor - protect producers (I.e minimum wages)
Economic Value Added - helps firms to avoid
hidden-cost fallacy by taking all the capital costs in
account including the cost of equity
Company - can be thought of as a series of
transactions.
Well-designed organization - rewards employees who
identify and consummate profitable transactions or who
stop unprofitable ones.
Costs - are associated with decisions.
Fixed costs - do not vary with the amount of output.
Variable costs - change as output changes.
Implicit costs - that do not show up in the accounting
statements; they nevertheless affect managerial decisions
Opportunity cost - of an alternative is what you give up
to pursue it.
Economists - argue that there is an opportunity cost
associated with all decisions
Sunk-cost fallacy - fixed-cost fallacy; means that you
consider costs and benefits that do not vary with the
consequences of your decision; you make decisions using
irrelevant costs and benefits.
Accounting profit - does not necessarily correspond to
economic profit.
Hidden-cost fallacy - occurs when you ignore relevant TC
MARGINAL COST =
costs—those costs that do vary with the consequences of Q
your decision. CHANGE IN PROFIT = MR- MC

Average cost (AC) - is irrelevant to an extent decision; CUSTOMER ACQUISITION COST =

Total cost of Sales and Marketing
“hide” fixed costs by lumping them together with variable ;
No. of Acquired Customers
costs.
ACCOUNTING PROFIT = Sales - Expenses
Marginal cost (MC) - is the extra cost required to make and (EXPLICIT)
sell one additional unit of output. Ex: Concert tickets
Cost: 1,000
Marginal revenue (MR) - is the additional revenue gained
from selling one more unit. Food: 500
1,500 Explicit costs
Sell more if MR > MC;
ECONOMIC PROFIT = Sales - Expenses - Implicit
Sell less if MR < MC; Cost
Ex: Work
If MR = MC, you are selling the right
Rate: 70/hr
amount (maximizing profit). Hours: 8 hours

An incentive compensation scheme that increases marginal 560 Implicit costs

revenue or reduces marginal cost will increase effort.
Fixed fees have no effects on effort.
A good incentive compensation scheme links
ECONOMIC LOSS = Explicit + Implicit
= 1,500 + 560
- All investment decisions involve a trade-off between
current sacrifice and future gain.

pay to performance measures that reflect effort. - Before investing, you need to know is whether the

Economics do not consider sunk cost in their decision future gains are bigger than the current sacrifice.
making. Discounting is a tool that allows you to figure this out.

Economics is often called the “dismal science,” partly - Although NPV is the correct way to analyze
because of its dark view of human nature. investments, not all companies use it. Instead, they use
breakeven analysis because it is easier and more
Accounting profit - is the total revenues minus explicit
intuitive.
costs, including depreciation.
- Avoidable costs can be recovered by shutting down. If
Economic profit - is total revenues minus
the benefits of shutting down (you recover your
total costs—explicit plus implicit costs.
avoidable costs) are larger than the costs (you forgo
Explicit costs - are out-of-pocket costs for a firm—for revenue), then shut
example, payments for wages and salaries, rent, or materials.
down.
In ACCOUNTING, interests are NOT considered
- The breakeven price is average avoidable cost.
In ECONOMICS, deduct interests
If you incur sunk costs, you are vulnerable to
FORMULA post-investment hold-up. Anticipate hold-up and choose
contracts or organizational forms that give each party
TOTAL REVENUE = P x Q
both the incentive to make sunk-cost investments and to
TOTAL COST = FC + VC
trade after these investments are made.
PROFIT = TR - TC
TR Compounding = FUTURE VALUE = PV (1  r) 2
MARGINAL REVENUE =
Q
 FV
Discounting = PRESENT VALUE =
(1  r) n
Net Present Value = should be POSITIVE

Ex:
Accounting Profit
Cost of Capital = 14%
OUTFLOW INFLOW INFLOW NET
1 2
Project 1 -P100.00 P115.00 N/A P15.00
Project 2 -P100.00 P115.00 P60.00 P20.00
Economic Profit
OUTFLOW INFLOW1 INFLOW2 NET
Project1 -P100.00 P100.88 N/A P.88
Project2 -P100.00 P52.67 P46.17 -P1.2

Inflow 1 is divided by 1.14; Inflow 2 is divided by 1.142

Projects with positive NPV create economic profit because

they earn a return higher than the company’s cost of capital.
By calculating the returns of Projects 1 and 2, we find that
Project 1’s return is higher than 14%, and Project 2’s is
lower than 14%. Projects with negative NPV may create
accounting

profit but not economic profit.

The breakeven quantity is the quantity that will lead to

zero profit.

FC
The Breakeven Quantity (Q) is:
(P - MC)

MC= same as VC

Contribution Margin (P-MC) - the amount that one sale

earns