AP Microeconomics Accounting Profits vs. Economic Profits Daily: What will I sacrifice if I quit my job to open a scrapbook store? What is the risk?

Accounting Profit 1.Accounting Profit = Revenue – Total Explicit Costs The actual numbers that an accountant can see and record!! Explicit Costs a.k.a. accounting costs or out-of-pocket costs The actual costs (both initial and monthly) that a business incurs –The variable & fixed costs

Economic Profit 2. Economic Profit = Accounting Profit – Implicit Costs All of the costs, including the what ifs and what was given up that an economist cares about. Implicit Costs: a.k.a. economic costs a.k.a. implied costs The revenues that are given up by making a different economic choice The costs that are “free” in the beginning of a business.

What can one learn from calculating economic profit that cannot be learned from calculating accounting profit?

John runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop and his materials costs $20,000 each year. John has $40,000 of his own money invested in equipment which could earn him an estimated $4,000 per year if otherwise invested. John has been offered $15,000 per year to work as a potter for a competitor. He estimates that his entrepreneurial talents are worth $3,000 per year. Hit total annual revenue from sales in his shop is $72,000. TRExplicit Implicit Capital Investment $72,000 {Costs an accountant would care about – only} $12,000 + $5,000 + $20,000 = $37,000 Opportunity Costs of Decisions, economists care about $4,000 + $15,000 + $3,000 = $22,000 Money that is tied up in tools - equipment $40,000

John runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop and his materials costs $20,000 each year. John has $40,000 of his own money invested in equipment which could earn him an estimated $4,000 per year if otherwise invested. John has been offered $15,000 per year to work as a potter for a competitor. He estimates that his entrepreneurial talents are worth $3,000 per year. Hit total annual revenue from sales in his shop is $72,000. TRExplicit Implicit Capital Investment $72,000$37,000 $22,000$40,000 Accounting Profit = TR – Explicit Costs $72,000 - $37,000 = $35,000

John runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop and his materials costs $20,000 each year. John has $40,000 of his own money invested in equipment which could earn him an estimated $4,000 per year if otherwise invested. John has been offered $15,000 per year to work as a potter for a competitor. He estimates that his entrepreneurial talents are worth $3,000 per year. Hit total annual revenue from sales in his shop is $72,000. TRExplicit Implicit Capital Investment $72,000 $37,000 $22,000$40,000 Economic Profit = TR – Explicit Costs – Implicit Costs -OR- Economic Profit = Accounting Profit – Imp Costs $35,000 - $22,000 = $13,000

John runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop and his materials costs $20,000 each year. John has $40,000 of his own money invested in equipment which could earn him an estimated $4,000 per year if otherwise invested. John has been offered $15,000 per year to work as a potter for a competitor. He estimates that his entrepreneurial talents are worth $3,000 per year. Hit total annual revenue from sales in his shop is $72,000. TRExplicit Implicit Capital Investment $72,000 $37,000 $22,000$40,000 Important to Notice: the capital investments money does not get touched!! It is tied into the business until the business is sold…not considered a loss!!

Samuel has started a band and plans on touring the area with his new rock band. It cost $25,000 for new instruments, $4,000 a year to lease a van for transportation, and $2,000 for advertising and a website. Sam had to drain his savings account and sell his stocks to buy the instruments, which was earning him $3,000 in interest and dividends. Sam is of course the lead singer and lead guitarist, but he is paying a bass player $300 per gig, his drummer $300 per gig, and his 2 back up singers $200 each per gig. He books play dates for $1,500 each and had 30 in their first year. By the way, Sam was a pediatrician who earned $120,000 last year. TRExplicit Implicit Capital Investment $1500 × 30 = $45,000 $4,000 + $2, ($ ) = $36,000 $3,000 + $120,000 = $123,000 $25,000 for instruments!!

Samuel has started a band and plans on touring the area with his new rock band. It cost $25,000 for new instruments, $4,000 a year to lease a van for transportation, and $2,000 for advertising and a website. Sam had to drain his savings account and sell his stocks to buy the instruments, which was earning him $3,000 in interest and dividends. Sam is of course the lead singer and lead guitarist, but he is paying a bass player $300 per gig, his drummer $300 per gig, and his 2 back up singers $200 each per gig. He books play dates for $1,500 each and had 30 in their first year. By the way, Sam was a pediatrician who earned $120,000 last year. TRExplicit Implicit Capital Investment $45,000 $36,000$123,000 $25,000 Sam’s Accounting Profit: $45,000 - $36,000 = $9,000 He made a good accounting decision!! Sam’s Economic Profit: $9,000 - $123,000 = $114,000 He made a terrible economic decision.

Isabella has decided to change her career. She was getting fed up with being a lawyer and working such long hours each day. She had a salary of $75,000. Isabella’s passion is dogs and she wants to open a doggie day care and grooming store. She had saved $35,000 from her previous job which she used to lease her location, hire two part time employees, and toys and materials. If she were still a lawyer that money would have earned her 10% interest in an aggressive money market fund. It took some time, but she managed to pick up quite a few clients who were willing to pay for this normal good. She has earned $27,000 from her dog grooming portion of her business. She also charges $50 per week for dogs to come for daycare (where they get to play with other dogs, have company all day, be walked and play outside). Her daycare business is open for 50 weeks a year (the other two she is on vacation) and she has fifteen committed clients. TRExplicit Implicit Capital Investment $27,000 + (50 × 15 × $50) = $64,500 $35,000$3,500 + $75,000 = $78,500

Isabella has decided to change her career. She was getting fed up with being a lawyer and working such long hours each day. She had a salary of $75,000. Isabella’s passion is dogs and she wants to open a doggie day care and grooming store. She had saved $35,000 from her previous job which she used to lease her location, hire two part time employees, and toys and materials. If she were still a lawyer that money would have earned her 10% interest in an aggressive money market fund. It took some time, but she managed to pick up quite a few clients who were willing to pay for this normal good. She has earned $27,000 from her dog grooming portion of her business. She also charges $50 per week for dogs to come for daycare (where they get to play with other dogs, have company all day, be walked and play outside). Her daycare business is open for 50 weeks a year (the other two she is on vacation) and she has fifteen committed clients. TRExplicit Implicit Capital Investment $64,500 $35,000$78,500 Isabella’s Accounting Profit: $64,500 - $35,000 = $29,500 She made a good accounting decision!! Her Economic Profit: $29,500 - $78,500 = $49,000 She made a terrible economic decision.