1. Production, Costs & Profits

2. Business & Firms
Firm: is a enterprise or organization that transforms inputs (factors of production such as natural resources, capital resources and human resources) into outputs (goods and services)
Production: is the process of transforming inputs into outputs
Input Production Process Outputs
Example;
Firms
Inputs
Outputs
McDonald’s
Beef, bun, cooking equipment, workers, etc.
Burgers
Honda
Auto parts, machines, equipment, workers, etc.
Cars

3. Productive Efficiency
Example; Imagine that you were Chief Executive Officer (C.E.O.) of Honda. Now, Honda has decided to produce one million cars this year. Your job is to choose the production process from the following two options.
Question: As the C.E.O. of Honda, which production process (a labour- intensive process or capital intensive process) would you choose?
Economists assume that the objective of a firm is to maximize profits and consequently minimize costs
Thus, with this objective, the firm would maximize productive efficiency (i.e. making a given quantity of output at the lowest cost). Hence, Honda should choose the least costly mix of inputs (Process B)
Production Plants (Capital)
Workers (Labour)
Process A
2 ($2 million/year)
2000 ($2 million/year)
Process B
3 ($2.4 million/year)
1500 ($1.5 million/year)

4. Revenue Total Revenue (TR): is equal to price times quantity
TR = Price × Quantity
Total revenue can be represented by the area under the demand curve

5. Economic Costs & Economic Profits
Economic costs: are the payments the firm needs to make or provide to attract needed resources to produce
From a firm’s point of view, there are two types of costs that it incurs, explicit and implicit costs
Economic Costs = Explicit Costs + Implicit Costs
Explicit costs (Accounting costs): are the monetary payments. These are the costs actually paid out in money.
Example; The costs of hiring workers (labour costs) or the costs of using equipment (capital costs)

6. Implicit Costs: are the opportunity costs of using the firm’s self-owned, self-employed resources
These are costs which do not require an actual expenditure of money
Example; Owner’s opportunity cost of being involved with a business (e.g. the income that the owner can earn in the labour market)

7. Objectives of the Firm
The primary objective of the firm is profit maximization, but alternative objectives may exist such as:
Increasing market share
Revenue maximization
Shareholder wealth maximization
Accounting Profit: is income as reported on the income statement
Accounting Profit = Total Revenue – Explicit Costs
Economic Profit: is accounting profit less the implicit opportunity costs not included in the explicit costs.
Economic Profit = Total Revenue – Economic Costs

8. Sources of Economic Profit
The economic profit for a firm can originate from sources such as:
Competitive advantage
Exceptional managerial efficiency or skill
Difficult to copy technology or innovation (patents, copyrights)
Exclusive access to less-expensive inputs
Preferential treatment under government policy
Exertion of monopoly power (price control) in the market
Market barriers to entry that limit competition

9. Example; Economic Costs & Profit
Example; Imagine that you were a software designer. Last year, you left your job which paid $70,000 a year and then you started your own software company.
This year your company sold 1,000 software at $100 each. You hired a programmer and paid her $30,000 annually. The capital cost (costs of computers, equipment etc.) is $10,000
Questions:
1) What is the firms total revenue?
Total Revenue = Price × Quantity = $100 × 1,000 = $100, 000
2) What are the firms explicit costs?
Explicit costs = Labour costs + Capital costs = $40, 000

10. 3) What is the firm’s accounting profit?
Accounting profit = Total Revenue – Explicit costs = $60, 000
4) What are the firm’s economic costs?
Economic Costs = Explicit Costs + Implicit Costs = $110,000
5) What is the economic profit?
Economic Profit = Total Revenue – Economic Cost = -$10,000

11. Determining Accounting Profit

12. Determining Economic Profit

13. Economic Versus Accounting Profit

14. Economic Profit
The concept of economic profit tells the firm whether it should remain in business, or instead shut down
Economic Profit > 0 , the firm has a positive economic profit and the owner should remain in business.
Economic Profit =0 , when the total revenue just equals to the economic costs, we say the firm is making normal profit.
In this case the firm is indifferent between remaining in business and shutting down.
Thus, zero economic profit is the minimum amount of profit necessary to key the firm in business
Economic Profit < 0, if the firm has negative economic profit or economic loss, the owner should consider shutting down.