1. Defining Profit Module KRUGMAN'S MICROECONOMICS for AP* 16 52 Micro:
Margaret Ray and David Anderson

2. What you will learn in this Module:
What is the difference between an explicit and implicit cost?
How many types of profit are there, and how can we calculate them?
Is $0 profit ever ok?
The purpose of this module is to introduce and define profit. Firms are assumed to maximize profit, but economists and accountants differ in how they define profit.

3. π = total revenue – total cost
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 [55]
Total revenue equals the price paid times the number sold.
TR = P x Q
Firms are assumed to produce the level of output that maximizes profit. Profit is equal to total revenue minus total cost.
π  = Total Revenue – Total Cost
Accountants and economists both define total revenue as equal to the quantity of units sold multiplied by the price at which they were told. In other words:
TR = P*Q
The more difficult component of profit is the precise definition of total cost (which comes up in module 55).

4. Implicit versus Explicit Costs
An explicit cost is a cost that involves actually laying out money.
Implicit versus Explicit Costs
An explicit cost is a cost that involves actually laying out money.
An implicit cost does not require the spending of money; it is measured by the value, in dollar terms, of the benefits that are given up or not chosen.
Businesses can face implicit costs for two reasons.
A business’s capital could have been put to use in some other way.
The owner devotes time and energy to the business that could have been used elsewhere.
All costs are opportunity costs. They can be divided into explicit costs and implicit costs.
An explicit cost is a cost that involves actually laying out money.
Examples include: Rent for office space, wages to employees, interest on debt, raw materials, depreciation on equipment, and utility bills.
These are referred to as “accounting costs.”
An implicit cost does not require an outlay of money; it is measured by the value, in dollar terms, of the benefits that are forgone.
Examples include: forgone salary, interest income given up when savings were liquidated, a building or other capital that could be rented but is self-employed.
These are referred to as “economic costs.”

5. Accounting versus Economic Profit
Accounting costs include only EXPLICIT costs
Accounting profit equals total revenue minus total EXPLICIT costs
Accounting π = TR – TC (explicit)
Economic costs include BOTH explicit and implicit costs
Economic profit is total revenue minus total costs (including both explicit and implicit costs)
π = TR – TC (explicit + implicit)
Companies report their accounting profit, which is not necessarily equal to their economic profit.
Accounting profit of a business is the business’s revenue minus the explicit costs and depreciation.
π = Total Revenue – Total Explicit Costs
Economic profit of a business is its revenue minus the opportunity costs of its resources; both explicit and implicit. It is usually less than the accounting profit.
π = Total Revenue – Total Explicit Costs – Total Implicit Costs

6. Normal Profit
An economic profit equal to zero is known as a “Normal profit”
A normal profit means that all costs (explicit and implicit) are covered by revenues.
When a firm is earning a normal profit, it can do no better using resources in the next best alternative use.
When economic profit is equal to zero, or break-even, the firm is said to be earning a “normal profit”.
What’s so great about breaking even?
Of course Betsy would love to have a positive economic profit, but let’s see what a normal profit means.
If Betsy has zero economic profit, Betsy has sold enough clothing to:
1. Pay all of her employees, insurance company, utilities, the bank, and her clothing suppliers. And!
2. Compensate her for all of the rental income she gave up and the Macy’s salary that she gave up.
If you can earn enough total revenue to cover every cost, both out of pocket and the things you gave up, a normal profit is not such a bad thing.

7. Try it out
In his spare time, Jim Murphy likes to sell sweet potatoes down by the river. During an interview with the school newspaper he said, “The materials cost me just 30 RMB, plus my time which is free. If I sell just 15 sweet potatoes I can break even, which I usually do every hour.
a. Is he talking about economic profit or accounting profit? Explain the difference between the two.
b. Discuss Jim's statement from economic perspective (taking the opportunity cost into account, that is).
c. If Jim talks his wife into joining him in his hobby and buys another set of tools, would you consider it the short run or the long run decision? Discuss the possible difference between the two.
When economic profit is equal to zero, or break-even, the firm is said to be earning a “normal profit”.
What’s so great about breaking even?
Of course Betsy would love to have a positive economic profit, but let’s see what a normal profit means.
If Betsy has zero economic profit, Betsy has sold enough clothing to:
1. Pay all of her employees, insurance company, utilities, the bank, and her clothing suppliers. And!
2. Compensate her for all of the rental income she gave up and the Macy’s salary that she gave up.
If you can earn enough total revenue to cover every cost, both out of pocket and the things you gave up, a normal profit is not such a bad thing.

8. Try it out
Your business has discovered a cheap and efficient technology of turning used plastic bottles and bags into various products. You limit your attention to the following two production opportunities: you can produce plastic utensils or helmets. In the first case your estimated annual revenue is $25,000, while the production will cost you $8,000. However, in your second option, you expect to sell 2000 helmets every year at $10 each, and the average total cost of every helmet will be $2.
a. Which production opportunity will you choose and why?
b. If you do so, what will be your economic profit?
When economic profit is equal to zero, or break-even, the firm is said to be earning a “normal profit”.
What’s so great about breaking even?
Of course Betsy would love to have a positive economic profit, but let’s see what a normal profit means.
If Betsy has zero economic profit, Betsy has sold enough clothing to:
1. Pay all of her employees, insurance company, utilities, the bank, and her clothing suppliers. And!
2. Compensate her for all of the rental income she gave up and the Macy’s salary that she gave up.
If you can earn enough total revenue to cover every cost, both out of pocket and the things you gave up, a normal profit is not such a bad thing.

9. Try it out
The sole proprietor of “Gudu-gudu" receives all accounting profits earned by her firm and a $28,000-a-year salary she pays herself. She has a standing salary offer of $35,000 a year if she agrees to work for a large corporation. If she had invested her capital outside her own company, she estimates that would have returned $22,000 a year. Last year, her accounting profit was $50,000.
a. What was her economic profit?
b. Did she earn normal profit? Why or why not?
When economic profit is equal to zero, or break-even, the firm is said to be earning a “normal profit”.
What’s so great about breaking even?
Of course Betsy would love to have a positive economic profit, but let’s see what a normal profit means.
If Betsy has zero economic profit, Betsy has sold enough clothing to:
1. Pay all of her employees, insurance company, utilities, the bank, and her clothing suppliers. And!
2. Compensate her for all of the rental income she gave up and the Macy’s salary that she gave up.
If you can earn enough total revenue to cover every cost, both out of pocket and the things you gave up, a normal profit is not such a bad thing.