Micro Ch 20- presentation 3 Explicit and Implicit Costs
Download
Report
Transcript Micro Ch 20- presentation 3 Explicit and Implicit Costs
Presentation 3- Cost of Production
Cash expenditures a firm makes to those who
supply labor services, materials, fuel,
transportation etc.
Cash payments for the use of resources
owned by others ($$ value)
Opportunity cost of using self-owned, selfemployed resources
Amount of $$ that self-employed resources
could have earned in their best alternative
use
Ex- using a building rather than renting
it…the amount of rent you could have made
The value or worth the resources used to
produce a good would have in its best
alternative use
Ex- steel in a building could be used for cars
Ex- for an assembly line worker making
computers, the contribution he could have
produced for another good
The payments a firm must make, or the
incomes it must provide, to attract the
resources away from alternative production
opportunities.
These payments can be explicit or implicit.
The minimum payment you must receive for
performing entrepreneurial functions for a
firm rather than for yourself
Included in implicit costs
Profit
= Total RevenueExplicit Costs
Profit
= Total Revenue –
Economic Costs (Implicit
and Explicit Costs)
You have been earning $22,000/yr. You
decide to open your own T-Shirt company.
You invest $20,000 of savings that have
earning you $1000/year in interest. Your
firm will be in a small store that you own and
have been renting out for $5000/year. You
also hire a clerk for $18000/year. Calculate
Accounting and economic profit
Total Sales Revenue………………..120,000
Cost of t-shirts…………40000
Clerk’s salary…………...18000
Utilities…………………...5000
TOTAL COSTS (Explicit)………………………(63,000)
ACCOUNTING PROFIT…………………………$57,000
$57,000 accounting profit looks good but
doesn’t include implicit costs and overstates
the economic success of the company.
By providing your own financial capital,
building and labor you incur implicit costs
(forgone income):
Accounting Profit………………………57000
Forgone interest……………………….1000
Forgone rent…………………………...5000
Forgone wages………………………..22000
Forgone entrepreneurial income….5000
TOTAL Implicit Costs…………………………….(33000)
Economic Profit……………………………………$24000
ECONOMIC Profit = TR-ECONOMIC COSTS
= 120000 – 63000-33000
= $24000
Gomez runs a small pottery firm. He hires one
helper at $12,000 per year, pays annual rent of
$5,000 for his shop, and spends $20,000 per year
on materials. He has $40,000 of his own funds
invested in equipment (pottery wheels, kilns, and
so forth) that could earn him $4,000 per year if
alternatively invested. He has been offered
$15,000 per year to work as a potter for a
competitor. He estimates his entrepreneurial
talents are worth $3,000 per year. Total annual
revenue from pottery sales is $72,000. Calculate
accounting profits and economic profits for
Gomez’s pottery.
Explicit costs: $37,000 (= $12,000 for the
helper + $5,000 of rent + $20,000 of
materials). Implicit costs: $22,000 (=
$4,000 of forgone interest + $15,000 of
forgone salary + $3,000 of
entrepreneurship).
Accounting profit = $35,000 (= $72,000
of revenue - $37,000 of explicit costs);
Economic profit = $13,000 (= $72,000 $37,000 of explicit costs - $22,000 of
implicit costs).