What is economic value added and how does it work? (2023)

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  • Surplus refers to an excess of production or supply over demand.
  • Economic surplus is made up of two parts, consumer surplus and producer surplus, and is a measure of market welfare.
  • Certain factors such as over or under production and taxes can affect the economic value added and the efficiency of the market.

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(Video) Economic Value Added EVA

The term "surplus" usually refers to having more of something than is actually needed or used. But what surplus actually means can be very different in different contexts.

What is economic surplus?

A budget surplus occurs when the state receives more tax revenue than it spends. Since money is left over, there is a budget surplus.

But an excess isn't always a good thing. From a business perspective, excess inventory can mean having excess inventory due to a lack of demand. There is also economic surplus, which refers to the sum of two parts - consumer surplus and producer surplus - and reflects the surplus value enjoyed by each party in a particular economic activity. Although there are several types of surplus with different definitions, we will mainly focus on economic surplus.

Understand how economic added value works

Economic value refers to the respective gains made by a consumer or producer in an economic activity, and is the combined benefit sometimes referred to as “total welfare”. It can also be referred to as the overall surplus or community surplus.

This economic metric is used to assess the well-being in the markets. When a consumer spends an item for less than they are willing to pay, the consumer deserves value. When a producer sells a good for more than the minimum price at which it is willing to sell it, the producer earns a surplus.

The economic added value follows the rules of supply and demand. Businesses often want to make as much profit as possible without alienating customers, while consumers generally want to feel like they're closing a deal.

(Video) Economic Value Added EVA - ACCA APM Revision Lecture

When supply and demand from consumers and producers are in good shape, the market is in what is known as “equilibrium” or allocative efficiency.

In a competitive market, the market is in equilibrium when the price of a good or service is such that the total quantity of that good or service that buyers want and can buy is exactly equal to the total quantity that sellers want and can buy. sell.” explainsDr. A. S. Zoe Plakias, Assistant Professor in the Department of Agricultural, Environmental, and Development Economics at Ohio State University. "At equilibrium price and quantity in a perfectly competitive market, total surplus, which is the sum of consumer surplus and producer surplus, is maximized. When rent is maximized in a market, the market is said to be efficient."

The equilibrium price denotes the price at which the goals of consumers and producers coincide. In other words, it is the price at which consumers are willing to buy and producers are willing to sell. Equilibrium quantity means the exact quantity of a given good at which supply and demand meet.

What types of economic added value are there?

Economic surplus consists of two parts: consumer surplus and producer surplus. These two types of surplus are different, but both represent a specific gain for the consumer or producer.

What is economic value added and how does it work? (1)

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consumer surplus

Consumer surplus refers to the monetary benefit that a consumer receives by purchasing a good for less than the maximum amount he would be willing to pay in this scenario. Consumer surplus refers to marginal utility, or the highest price you would pay less what you actually paid.

producer surplus

Producer surplus refers to the monetary gain producers make by selling a given good above the lowest price at which they would be willing to sell it. Marginal cost refers to the additional cost a producer incurs to produce more of a given good.

(Video) Economic Value Added EVA

When there is an "equilibrium" between consumer surplus and producer surplus, both marginal utility and marginal cost have the same value.

What Causes an Economic Surplus?

As already mentioned, the concept of economic added value is closely linked to supply and demand. In other words, how much of a given good is available and what is the demand for it?

The law of supply and demand is inherently linked to consumers and producers, the two parties that create economic value. The law of supply suggests that as the price of a given good increases, so does its quantity, or supply. The opposite is also true, because when the price goes down, the supply goes down too.

The law of demand suggests that as the price of a given item increases, the demand for it decreases. In other words, when something goes up in price, there are fewer consumers in the market willing to pay for it. The opposite is also true, so when the price goes down, the demand goes up.

The main cause of economic surplus is when supply and demand for a given good are out of sync. This disrupts the market equilibrium, which can lead to changes in the price of a particular good or the quantity produced.

Factors that can affect economic value and market efficiency include:

  • overproduction,or have too much of a particular item produced.
  • underproduction, or have very little of a particular item made.
  • Steer, as this can result in higher prices for consumers and lower production for suppliers.
  • High transaction costs, which can be prohibitive for both consumers and manufacturers.

“These surpluses are caused by a mismatch between supply and demand. If there are too many TVs in stock, suppliers may have to lower prices and even sell at a loss to reduce inventory,” Tsang explains. "But if those same TVs are in short supply and demand stays the same or even increases, they may sell for more than we would normally be willing to pay."

the bottom line

Surplus can refer to many things, but economic surplus is used to assess market conditions and benefits to consumers and producers. But it's a small part of something much bigger.

(Video) How to Find a Company's TRUE Profit - Economic Value Added Explained Simply

"This idea of ​​surplus simply captures the costs and benefits of production and consumption that fall on buyers and sellers," Plakias notes. "For example, if some costs or benefits are borne by others outside of the market, or if the market is not perfectly competitive, then without any intervention, the price and quantity we see in the market is generally not efficient and I probably want to." do it as a society."

In this case, the government can play a role in market conditions. When assessing economic added value, it is important to remember that it is not everything.

Plakias notes that "total surplus tells us nothing about equity and the distribution of benefits among the people in the economy who we care about as a society and who we probably want to consider in our decisions."

Melanie Locker

Melaniedropsis the founder of the blog and author of the book,"love guilt." On his blog, he chronicled his journey through $81,000 in student loan debt. His work has been published in Business Insider, Time, the Huffington Post, and others. She is also co-founder ofLola retreat, which helps brave women face their fears, pursue their dreams, and develop a plan to take control of their finances.


What is economic value added in simple words? ›

Economic value added (EVA), also known as economic profit, aims to calculate the true economic profit of a company. EVA is used to measure the value a company generates from funds invested in it.

What is economic value added and how is it calculated? ›

EVA aims to represent a company's true economic profit. It measures the value a company generates based on the funds that others invested in it, making it extremely reliant on invested capital. It represents the excess profit above the cost of capital, after adjustments for taxes, presented on a cash basis.

How do you do economic value added? ›

To calculate economic value added, determine the difference between the actual rate of return on assets and the cost of capital, and multiply this difference by the net investment in the business.

What are the benefits of EVA? ›

There are several benefits to using EVA analysis. EVA helps companies to make more strategic decisions, as well as to identify areas that need improvement. By evaluating a company's economic performance, it can be easier to identify areas where resources need to be allocated in order to maximize value.

What is the term EVA used for? ›

EVA stands for Economic value added. In corporate finance, economic value added (EVA) is an estimate of a firm's economic profit, or the value created in excess of the required return of the company's shareholders. EVA is the net profit less the cost of the firm's capital.

What is economic value example? ›

Examples of Economic Values

Convenient products and services are those that are easy to get, easy to use, adaptable, and dependable; on the other hand, high fidelity products and services provide quality, status, aesthetic appeal, and emotional effect.


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