Defining Profit

Primary goal of most firms is to maximize profit A firms profit equals its total revenue So profit equals total revenue- total costs (is the cost of all inputs used to produce its output) PxQ-total cost= profit

Explicit vs. Implicit cost Explicit cost The cost that involves actually laying out money Ex. The explicit cost of a year of college includes tuition Implicit cost It does not require an outlay of money; it is measured by the value, in dollar terms, of benefits that are foregone. Ex. The implicit cost of a year of college includes the income you would have earned if you had taken a job instead

A common mistake is to ignore implicit cost and focus on explicit cost Sometimes implicit cost is much larger than explicit cost

Accounting profit vs. Economic profit Is a business’s total revenue minus the explicit cost and depreciation This is the number a business must report on income tax forms and to anyone thinking of investing in a business

Economic profit It is a business’s total revenue minus the opportunity cost of its resources. It is usually less than accounting profit Economists use term profit to refer to economic profit

A business may have an implicit cost that is over and above the explicit cost Two reason for this A business’s capital (i.e. buildings, equipment, tools, inventory, and financial assets) 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

Implicit cost of capital It is the opportunity cost of the capital used by a business; it reflects the income that could have been earned if the capital had been used in its next best alternative way.

When a business owner is earning an economic profit their total revenue is higher than the sum of implicit and explicit cost

When an economic profit equals zero it is called normal profit Positive economic profit indicates that the current use is the best use of resources Negative economic profit indicates that there is a better alternative use for resources When an economic profit equals zero it is called normal profit It is an economic profit just high enough to keep a firm engaged in its current activity