KRUGMAN'S
MICROECONOMICS for AP*
Defining Profit
Margaret Ray and David Anderson
Micro:
Econ:
16
52
Module
What you will learnin this Module:
•The difference between explicit andimplicit costs and their importance indecision making.
•The different types of profit, includingeconomic profit, accounting profit, andnormal profit.
•How to calculate profit.
Understanding Profit
•Implicit versus explicitcosts
•Accounting profitversus economic profit
•Normal profit or “ZeroEconomic 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 thenumber 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 actuallylaying out money.
•An implicit cost does not require an outlay ofmoney; 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 insome other way.
•The owner devotes time and energy to thebusiness that could have been used elsewhere.
Accounting versusEconomic Profit
•Accounting costs include only EXPLICIT costs
•Accounting profit equals total revenue minus totalEXPLICIT costs
Accounting π = TR – TC (explicit)
•Economic costs include BOTH explicit and implicitcosts
•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 andimplicit) are covered by revenues.
•When a firm is earning a normal profit, it can do nobetter using resources in the next best alternativeuse.
Betsy earns $250,000 in TR from her clothingstore 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=$250,000-14,400-35,000-40,000-150,000= $10,600
Economic Profit= TR-TC-Implicit Costs
•Other Implicit Costs
•Foregone rental income on herbuilding=$1000 month *12= $12,000
•Foregone Salary at Macy’s=$45,000
•P= $250,000-14,400-35,000-40,000-150,000-12,000-45,000= -$46,400
•If TR= $296,440-14,400-35,000-40,000-150,000-12,000-45,000= 0 or zeroeconomic profit or break even , called“normal”