KRUGMAN'SMICROECONOMICS for AP*

Defining Profit

Margaret Ray and David Anderson

Micro:

Econ:

16

52

Module

What you will learnin this Module:

• The difference between explicit and implicit costs and their importance in decision making.

• The different types of profit, including economic profit, accounting profit, and normal profit.

• How to calculate profit.

Understanding Profit

• Implicit versus explicit costsImplicit versus explicit costs

• An explicit cost is a cost An explicit cost is a cost that involves actually laying that involves actually laying out money.out money.

• These are referred to as These are referred to as “accounting costs.”“accounting costs.”

• An implicit cost does not An implicit cost does not require an outlay of money; require an outlay of money; it is measured by the value, it is measured by the value, in dollar terms, of the in dollar terms, of the benefits that are forgone. benefits that are forgone.

• These are referred to as These are referred to as “economic costs.”“economic costs.”

Understanding Profit

• Accounting profit versus Accounting profit versus economic profiteconomic profit

• An explicit cost is a cost that An explicit cost is a cost that involves actually laying out involves actually laying out money.money.

• These are referred to as These are referred to as “accounting costs.”“accounting costs.”

• An implicit cost does not An implicit cost does not require an outlay of money; it require an outlay of money; it is measured by the value, in is measured by the value, in dollar terms, of the benefits dollar terms, of the benefits that are forgone. that are forgone.

• These are referred to as These are referred to as “economic costs.”“economic costs.”

Understanding Profit

• Normal profit

An economic profit An economic profit is equal to zerois equal to zero

Defining Profit

•Profit is equal to total revenue minus total cost

•Economists use the symbol π to represent profit

π = total revenue – total cost

π = TR – TC

• Total revenue equals the price paid times the number sold.

TR = P x Q

Implicit versus Explicit Costs

•An explicit cost is a cost that involves actually laying out money.

•An explicit cost is a cost that involves actually laying out money.

•An implicit cost does not require an outlay of money; it is measured by the value, in dollar terms, of the benefits that are forgone.

•Businesses can face implicit costs for two reasons.

•A business’s capital could have been put to use in some other way. •The owner devotes time and energy to the business that could have been used elsewhere.

Accounting versus Economic Profit

• Accounting costs include only EXPLICIT costs

• Accounting profit equals total revenue minus total EXPLICIT costs

Accounting π = TR – TC (explicit)

• Economic costs include BOTH explicit and implicit costs

• Economic profit is total revenue minus total costs (including both explicit and implicit costs)

π = TR – TC (explicit + implicit)

Normal Profit

• An economic profit equal to zero is known as a “Normal profit”

• A normal profit means that all costs (explicit and implicit) are covered by revenues.

• When a firm is earning a normal profit, it can do no better using resources in the next best alternative use.

Table 52.1 Opportunity Cost of an Additional Year of SchoolRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Table 52.2 Profit at Babette’s Cajun CaféRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers