KRUGMAN'S MICROECONOMICS for AP* Defining Profit Margaret Ray and David Anderson Micro: Econ: Module

What you will learn in 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 costs Accounting profit versus economic profit Normal profit or “Zero Economic profit”

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 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.

Betsy earns $250,000 in TR from her clothing store per year Accounting Profit= TR- TC Other Explicit Costs: $1200 month loan payment* 12=$14,400 Annual wages =$35,000 Annual insurance/utilities = $40,000 Annual Inventory =$150,000 P=$250,000-14,400-35,000-40, ,000= $10,600 Economic Profit= TR-TC-Implicit Costs Other Implicit Costs Foregone rental income on her building=$1000 month *12= $12,000 Foregone Salary at Macy’s=$45,000 P= $250,000-14,400-35,000-40, ,000-12,000-45,000= -$46,400 If TR= $296,440-14,400-35,000-40, ,000-12,000-45,000= 0 or zero economic profit or break even, called “normal”