Accounting Profit
Accounting profit is calculated by subtracting this costs from total revenue.
What are explicit costs?
When economic profit equals zero, economists say the firm is earning what type of profit?
What is the cost type that does not change with output?
Fixed costs (FC)
Total revenue is calculated by multiplying these two variables.
What are price and quantity?
Accounting profit does not subtract these types of costs, leading to a difference from economic profit.
What are implicit (opportunity) costs?
If TR = $350, explicit costs = $100, and implicit costs = $50, the economic profit is this amount.
What is $200?
What are the costs that change with output, like ingredients or materials?
Variable costs (VC)
If a firm’s explicit cost is $700, implicit cost is $400, and revenue is $1,000, the economic profit is?
-$100
A business has $50,000 in revenue and $30,000 in explicit costs. This is its accounting profit.
What is $20,000?
If TR = $1,000, explicit costs = $600, and implicit costs = $400, the economic profit is this amount.
What is $0?
Investing $1,000 in your business instead of the stock market means giving up potential investment earnings. What is this cost?
Implicit cost or opportunity cost.
What is the FULL profit formula? Hint, it needs to have FC and VC in it.
P = [PxQ] - [FC+VC]
A business reports the following for the year:
Total revenue: $480,000
Wages paid: $150,000
Raw materials: $90,000
Machines paid: $36,000
Interest paid on a business loan: $12,000
The owner uses a building they personally own, but they COULD rent it out for $30,000 per year.
What is the firm’s accounting profit?
What is $192,000?
The $30,000 the owner could earn renting the building is an implicit cost. Therefore you don't add it while calculating.
150000 + 90000 + 36000 + 12000 = $288000
480000 - 288000 = $192,000
Economic profit becomes negative when the sum of explicit and implicit costs exceeds...
What is total revenue?
(Because not only is the company failing to cover its FC, but it is also not compensating for the opportunity costs or VC.)
When marginal cost is below average total cost, average total cost does this.
What is decrease?
A firm’s implicit costs increase. This will always cause this effect on economic profit.
What is economic profit decreases?
If implicit costs increase while revenue and explicit costs stay the same, what happens to economic profit?
It decreases.
(This is because as the OC increases, your revenue and explicit cost can't cover the implicit cost, and your TR decreases)
This cost curve is U-shaped because of diminishing marginal returns, which causes marginal cost to rise after a certain point, pulling this curve upward with it.
What is the average total cost (ATC) curve?
A firm has the following data:
Total revenue = $300,000
Explicit costs = $210,000
Implicit costs = $95,000
The firm should still shut down in the long run because of this economic condition.
What is negative economic profit (–$5,000)?
Accounting profit = 300,000 – 210,000 = $90,000
Economic profit = 300,000 – (210,000 + 95,000)
= 300,000 – 305,000
= –$5,000
Even though accounting profit = positive, the owner’s resources would make more money elsewhere, meaning the firm is destroying economic value. In the long run, firms with negative economic profit exit the industry.