Economics of energy
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2. How do the concepts of accounting profit and economic profit differ? Why is economic profit smaller than accounting profit? What are the three basic sources of economic profit? Classify each of the following according to those sources:
a. A firm's profit from developing and patenting a new medication that greatly reduces cholesterol and thus diminishes the likelihood of heart disease and stroke.
b. A restaurant's profit that results from construction of a new highway past its door.
c. The profit received by a firm benefiting from an unanticipated change in consumer tastes.
3. Suppose that you hear two people arguing about energy. One says that we are running out of energy. The other counters that we are running out of cheap energy. Explain which person is correct and why.
4. Recall the model of non-renewable resource extraction presented in Figure 15.7. Suppose that a technological breakthrough means that extraction costs will fall in the future (but not in the present). What will this do to future profits and, therefore to current user cost? Will current extraction increase or decrease? Compare this to a situation where future extraction costs remain unchanged but current extraction costs fall. In this situation, does current extraction increase or decrease? Does the firm's behavior make sense in both situations? That is, does its response to the changes in production costs in each case maximize the firm's stream of profits over time?
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Solution Summary
economic vs accounting profit; sources of economic profit; economics of energy
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2. Accounting profit occurs whenever revenues exceed expenses. Economic profit is a more subtle term that includes such things as the profit of the next best venture which could have been done instead. Because of the implicit costs in economic profit, it is smaller than accounting profit. The three sources of economic profit are market power (monopoly), innovation, and ...
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