Economic Profit
I picked up on a little bit of amusing geeky microeconomics yesterday. In college, we studied why firms in a perfectly competitive market have their profits driven to zero. This is also a fact about microeconomics that people commonly cite, often incorrectly. (I have heard Marxists use it to prove why the great capitalist machine will destroy itself.) I had misunderstood it until yesterday. I had assumed that meant that to the extent I read in the paper about firms being profitable, it meant that they were operating in markets that were less than perfectly competitive. This section in my micro book elegantly explains the distinction I missed:
When a firm goes into a business, it does so in the expectation that it will earn a return on its investment. A zero economic profit means that the firm is earning a normal–i.e., competitive–return on that investment. This normal return, which is part of the user cost of capital, is the firm’s opportunity cost of using its money to buy capital rather than investing it elsewhere. This, a firm earning zero economic profit is doing as well by investing its money in capital as it could by investing elsewhere–it is earning a competitive return on its money. Such a firm, therefore, is performing adequately and should stay in business. (A firm earning a negative economic profit, however, should consider going out of business if it does not expect to improve its financial picture.)