Unit 3:�Production, Costs, and Perfect Competition

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Topic 3.4-

Types of Profit

Revenue and Profit

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Total Revenue = Price x Quantity

Profit = Total Revenue - Total Cost

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4

Accountants vs. Economists

Accountants look at only EXPLICIT COSTS

• Explicit costs (out of pocket costs) are payments paid by firms for using the resources of others.
• Example: Rent, Wages, Materials, Electricity Bills

Economists examine both the EXPLICIT COSTS and the IMPLICIT COSTS

• Implicit costs are the opportunity costs that firms “pay” for using their own resources
• Example: Forgone Wage, Forgone Rent, Time

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Practice

Assume the following:

• David left his job as a lawyer earning $8,000 a month to open up an ice cream shop
• Last month he sold 5,000 sundaes for $2 each and 8,000 cones for $1 each
• His rent is $1000 per month
• His other expenses like labor, ice cream, cones, etc. add up to $9,000 per month
• Last month he took a family vacation that cost $5000
• Calculate David’s accounting profit
• Calculate David’s economic profit
• Should David go back to being a lawyer?
• What must be true for accounting profit if economic profit is zero?

No Economic Profit = Normal Profit

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7

From now on, assume that all costs we discuss are economic costs

(Example: if the average cost to produce a pizza is $4. That $4 includes explicit AND implicit costs)

2010 Audit Exam