Experimental economics

What is Economic value?

Economic value is an important concept in experimental economics. Economic value can be referred to as a measurement of benefits from goods or facilities. The measure of the values takes place in currency. Again economic value can also be referred to as the maximum amount of money that can be paid for value goods. The economic value should not be confused with market value, as the market value can be termed as the minimum amount of money that can be paid for goods or services. The values in economics are largely used by the producers for setting prices for their products, considering the tangible and the intangible factors like the name of a brand. Here it is important to understand the differences between price vs values. Price is paid for goods or facilities that we receive and values are what the goods or the services are paying us. Price of a compound can be the same for all the customers but definitely different for different customers. It is the economic value that helps us to gauge and define the values. The benefits of the economic values lie in the fact it helps us to make economic choices or options involving trade-offs for the allocation of the resources.

It should be mentioned that the economic values is not a static figure and alters with the change in the price and quality of the product. The companies use economic values for setting the price of the products. A practical example that can be provided with respect to the real world is the weight of the grades of degrees of college in various disciplines. A consensus has been found showing that the economic value of a college degree is more than that of a high school diploma. Again some of the degrees are more than the other.

What kind of economic value is generated by the finance industry?

The financial industry is a section of the economy that consists of institutions and firms that produce financial assistance to retail and commercial clients. The sector consisted of a large range of industries like banks, insurance companies, firms, real estates, and different investment companies. A large portion of values for money is generated by this sector from the loans and the mortgage and the values for the money is gained as there is a decrease in the interest rates. Understanding the financial industry is an important element of experimental economics. The true value of the economy depends upon the strength of the financial sector.  It supports that there is a proper allocation of the capital, especially when the capital is surplus, although on a temporary basis. One of the early devices was the use of the bill of exchange that allows a seller who had no immediate use for the payment of buyers that could earn interest allowing the buyers to give more capital.

This would create more value more than if the capital were not utilized. The companies of joint-stock and other financial machinery allow those who get the chance of utilizing the capital. However, the financial industry is much bigger. It might be possible that the farmers and the users of the grains might enter into futures contracts for hedging against the rise of prices. There is also a possibility that one side or the other has more dislike for the price risk. Hence, it might happen that the speculators might add values by selling or buying a part of the harvest.

One of the main economic value in the finance industry is to enhance liquidity. Liquidity helps to provide a faster and smoother transaction of money. It also helps to maintain sustainability in any economy. It is the stability that builds trust among the investors and the economy.  

What is the economic value of a business?

Studying the economic value of a business includes the study of the economic factors and their effect on business decisions, such as a change in the regulation of the industry or a sudden shift in the price of raw materials. In order to understand the value of economics, there are several tools like linear programming.

A large amount of money is generated by various businesses, thus strengthening the economy. The economic value of a business can be termed as the value that increases the flow of wealth of a business. I occur in such a manner that all internal and the external stakeholders enhance their physical, mental and ethnic wealth. In other words, it can be referred to as what value of money a particular business is bringing on the economy.  It is a bit different from that of the business value that states that it includes all kinds of values determining the health and the wellbeing of the firm in the long run. Rather, business value expands the concept the form value beyond the economic value.

What is Economic Value Added?

Economic value added (EVA) can be referred to as the financial performance of a company and is an important part of experimental economics. The financial performance of the company is on the basis of the residual wealth. The residual wealth is calculated by the deduction of the cost of the capital from the operating profit and is adjusted on the basis of cash. Economic value added can also be termed as the economic profit. This is because it tries to capture the true economic profit of a company. EVA has often been termed as the incremental difference in the return rate over the cost of capital. It is again used for the evaluation of the value generated by a company, from the fund that has been invested. If the Economic value added to a company is negative, then it would indicate the fact that the company has not been generating value from the funds that have been invested in the business. On the other hand, the economic value added indicating the production of values from the funds that have been invested in the company.

As per the equation of the Economic added value, there are three components- NOPAT, the amount of invested capital and WACC. One can calculate NOPAT manually, which is normally stated in the company's financials. The invested capital is the amount of money used for funding a particular project. WACC is the average percentage of return that a company pays to investors.

The formula of EVA can be calculated by the following algorithm:-

NOPAT - (Total Assets - Current Liabilities) * WACC

The primary objective of EVA is to assess the performance of a company and management through an idea, that a business can only be profitable when wealth and returns are created for the shareholders, thus requiring performance beyond the company's capital cost. EVA can act as a useful performance indicator. The calculation will be able to give a proper idea about how the wealth of a company is created, by the inclusion of the items in the balance sheet. This forces the managers to be knowledgeable about the expenses, profits, and assets of a company while considering administrative decisions. It should be mentioned that the calculation of EVA depends wholly on the invested amount of capital. It is the best used for those asset rich companies that have stable and mature capital. Companies that have intangible assets might not be the appropriate ones for the evaluation of the EVA.

The primary idea behind EVA is that business is profitable whenever they create money for their stakeholders. The main concept behind EVA is that business can only be perceived as profitable as wealth is created for the stakeholders. Economic value added states that returns should be created at a rate that is beyond the cost of the capital.

How can we explain with example?

The economic value added is an important term associated with experimental economics.

The Economic value added (EVA) is an internal management performance measure that differentiates the net profit to the total capital cost. EVA is calculated by the following formula:

EVA = Net Operating Profit after Tax - (Capital Invested x WACC)

Three components are necessary to calculate EVA: Then net operating the profit after the task (NOPAT), an invested capital and weighted average cost of capital (WACC), if no information is provided. The main rationale behind the multiplication of WACC and the invested capital is for the evaluation of the charge for using the invested capital. This is the amount that an investor should spend to make their investment meaningful. An example has been given below:-

Let us assume that a company ABC uses the following elements for calculating the EVA.

NOPAT = $3,380,000

Capital Investment = $1,300,000

WACC = .056 or 5.60%

EVA = $3,380,000 - ($1,300,000 x .056) = $3,307,200

Positive value suggests that the company has earned more than its cost of capital. Whereas the negative number indicates that the project has not exceeded the capital cost. The idea behind Economic value added (EVA) is important because it is used as an indicator of the profit percentages of the company primary and thus it helps in understanding the performance of the management. The calculation of the economic added value asserts that returns have to be created at a percentage that is above the cost of the capital. The calculation of the value-added has got several advantages. It provides a summary of how much has a company created wealth above the capital. The calculated balance sheet helps in the calculation and helps the managers to think about the assets and the liabilities. However, the adjustment of cash related to the calculation of the economic values can be time-consuming. Distortion in the values affects the measures, especially when it comes to differences in amortizations and depreciation. The economic value added is only applicable to the period measured. It is not predictive of the performance of the future, specifically for the companies in the midst of reorganization and to make more capital investments. The calculation of the Economic value added is solely on the invested capital and hence it is applicable to those companies having asset incentives and have more capital. EVA is more useful for those companies who are auto manufacturers, than the software companies or the service companies having a large number of intangible assets.

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References

Cost vs Price vs Worth vs Value. https://humancond.org/analysis/economics/price_vs_worth_vs_value
Economic Value. https://www.investopedia.com/terms/e/economic-value.asp
Economic Value Added (EVA). https://www.investopedia.com/terms/e/eva.asp
Economic Value Added (EVA). https://investinganswers.com/dictionary/e/economic-value-added-eva
Business value. https://en.wikipedia.org/wiki/Business_value
Economic Value Added (EVA). https://corporatefinanceinstitute.com/resources/knowledge/valuation/economic-value-added-eva/
Economic Value Added (EVA) | Formula | Calculation | Top Examples. https://www.wallstreetmojo.com/economic-value-added-eva/