Economic profit
Revenue less all costs, including the opportunity cost of the owners' capital. Zero means a normal return: enough to stay in the industry, not enough to attract entrants.
Where you will meet it
Economic profit appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Contrast market value with book value and link return on equity to the cost of equity
“The price-to-book ratio is therefore a statement about expected economic profit rather than about asset quality.”
- Work out return on invested capital and explain what it reveals
“Economic profit, the spread times invested capital, shows how much value is created in absolute terms.”
- Contrast monopoly, perfect competition and the market structures in between
“Under perfect competition firms are price takers: many sellers, an identical product, free entry, and long-run economic profit competed away to zero.”
- Explain how firms set price and quantity in oligopoly and monopolistic competition
“Under monopolistic competition, entry erodes economic profit in the long run.”
See also
Practise it
Practise economic profit until it is automatic: questions that explain every wrong option.
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