1. Unit 3: Costs of Production and Perfect Competition
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2. Revenue = Price x Quantity
Revenue and Profit
Revenue = Price x Quantity

3. 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
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
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
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)
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4. From now on, all costs we discuss will be ECONOMIC COSTS
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
From now on, all costs we discuss will be ECONOMIC COSTS
Accounting
Profit
Total
Revenue
Accounting Costs
(Explicit Only)
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
Economic
Profit
Total
Revenue
Economic Costs
(Explicit + Implicit)
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5. No Economic Profit = Normal Profit
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
$8,000= Revenue ($18,000) minus explicit costs ($10,000). Don’t include the family vacation since it is not a business expense.
$0= Revenue minus explicit costs and implicit costs ($8,000 forgone wage)
Not necessarily, he makes just as much money per month with his shop as he did being a lawyer.
Accounting profit must be positive when economic profit is zero
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6. Normal Profit
In an efficient competitive market, firms that have identical products will make a normal profit.
They will break even and make no economic profit
Traffic Analogy
When there is heavy traffic, why do all lanes go the same slow speed?
Cars leave slower lanes and enter faster lanes.
Similarly, what happens in perfectly competitive markets if firms earn excessive profit? 6
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7. Maximizing PROFIT! 7
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8. Assume every unit can be sold for $10. Which unit maximizes profit?
Use marginal analysis to explain why you should never produce 5 units
Marginal Cost
Price
$12
$10 $8 $6
Marginal
Revenue
Quantity
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9. Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11
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ACDC Leadership 2015

10. Profit Maximizing Rule Short-Run Profit Maximization
MR=MC
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11 10
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ACDC Leadership 2015