AboutWarren D. Miller, CFA, ASA, CMA, CPA Expertise My in-depth knowledge of economics is confined to three sub-disciplines: Austrian economics, industrial organization, and evolutionary economics. Other questions dealing with macroeconomics, the traditional neoclassical paradigm, labor economics, environmental economics, agricultural economics, health economics, and so on should go to those who have the appropriate expertise.
N.B.: I DO NOT ANSWER QUESTIONS MARKED 'PRIVATE' because I believe that knowledge should be shared, not hoarded. I also believe that such questions are likely to come those trying to cheat. Similarly, as one who was a full-time academic for half a decade, I can recognize test and homework questions several time zones away. Therefore, please do not demean yourself by submitting such questions to me. Those who do so are cheating, pure and simple, and I WILL call you out publicly if I believe you are doing so. I have a zero-tolerance policy where cheating and dishonesty are concerned.
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Experience I work with Austrian economics (which is different in major respects from the traditional neoclassical model), industrial organization (which is about industry structure, conduct, and performance), and evolutionary economics (almost, but not quite, the economic analog of its biological counterpart) everyday in my work. I appraise closely-held businesses, provide exit-planning services, and offer high-level strategic analysis, advice, and clients to CEOs and owners of mid-sized businesses. Understanding, applying, and writing about these disciplines is an essential part of how I have made my living since 1993.
Organizations CFA Institute, Strategic Management Society, American Society of Appraisers, Institute of Management Accountants, Academy of Management, Culver Legion
Publications CFA Magazine, Strategic Finance, Valuation Strategies, Value Examiner, Journal of Advanced Property Economics, Harvard Business Review, American Fly Fisher, CFA Digest, CPA Expert, and Business Valuation Review, among others
Education/Credentials MBA - Oklahoma State (1991)
BBA - U. of Oklahoma (1975)
Chartered Financial Analyst designation (2006)
Accredited Senior Appraiser (2006)
Certified Management Accountant (1992)
Certified Public Accountant (1992)
Question Hello, i saw your answer on a question about oppurtunity cost and it was very usefull to me. I would like to know how economic profit and oppurtunity costs are related.
My mind of thought was that the difference in company's A profit and Company B economic profit is the opportunity cost of company A. because they could have had a much higher profit but they didnt. so their next base allocation of resources would have led to the same or comparable proft of the company with the economic profit....
I am rigt at this point or is there another way these to subjects can be related to each other
Answer Thank you for your interesting questions, Jordy. Glad to help.
I do not see a connection between "economic profit" and "opportunity cost." Maybe I'm missing something, but I don't see it. Opportunity cost is simply the cost of the choice that was NOT chosen. I can do billable work for clients or I can go play golf. The cost of playing golf is not golf balls or greens fees. It's the money I COULD have made had I done billable work for clients. The cost of doing billable work for clients is golf balls and greens fees.
We can look at that another way, of course. Playing golf with a prospective new client might be a lot less expensive than doing billable work for clients. . .if the prospective new client would bring in more revenue than the work I'd be billing. In economics, we always have to have the facts of the situation. Generalizations are risky.
Now, there are three kinds of profit: accounting profit, tax profit, and economic profit. The first two are distortions of economic reality, and that is why we have the third. In terms of valuing a business, which is what I do for a living, the third one is the one that counts. I'll elaborate briefly because this is a long and complicated topic.
Accounting profit excludes returns on capital (dividends) that shareholders demand in order to be compensated for taking risk by investing in the company. However, it includes interest paid to lenders who also invested in the company by making loans to it. So, accounting profit treats two providers of capital--lenders and owners--differently. That's a distortion.
Tax profit allows all kinds of crazy things. For instance, under Sec. 179 of the U.S. Internal Revenue Code, a small business can write off in the first year up to $200,000 of investment in plant and equipment. So, for instance, that $100,000 numerically-controlled lathe sitting on the shop floor may have a tax basis of -0-, even though it's worth $80,000 on the open market.
Economic profit corrects these distortions and many others to numerous to mention here. But there are nearly 200 of them.
I hope this is helpful. Please do me a favor by completing the rate-the-expert email you'll receive about the same time you get this reply from me. Your ratings and, especially, your comments help me do a better job of helping folks like you who ask such interesting questions!
