AP Microeconomics
Accounting Profits vs. Economic Profits
Daily: What will I sacrifice if I quit my
job to open a scrapbook store? What
is the risk?
Accounting Profit
1. Accounting Profit = Revenue – Total
Explicit Costs
The actual numbers that an
accountant can see and record!!
Explicit Costs
•
a.k.a. accounting costs or out-of-pocket
costs
•
The actual costs (both initial and
monthly) that a business incurs
– The variable & fixed costs
Economic Profit
2. Economic Profit = Accounting Profit –
Implicit Costs
All of the costs, including the what ifs and
what was given up that an economist cares
about.
Implicit Costs:
• a.k.a. economic costs
• a.k.a. implied costs
• The revenues that are given up by making a
different economic choice
• The costs that are “free” in the beginning of
a business.
What can one learn from
calculating economic profit that
cannot be learned from
calculating accounting profit?
John runs a small pottery firm. He hires one
helper at $12,000 per year, pays annual rent of
$5,000 for his shop and his materials costs
$20,000 each year. John has $40,000 of his
own money invested in equipment which could
earn him an estimated $4,000 per year if
otherwise invested. John has been offered
$15,000 per year to work as a potter for a
competitor. He estimates that his
entrepreneurial talents are worth $3,000 per
year. Hit total annual revenue from sales in his
shop is $72,000.
TR
$72,000
Explicit
Implicit
$12,000
{Costs
an +
accountant
$5,000 +
would care
$20,000
=
about – only}
Opportunity
$4,000 + Costs
of
Decisions,
$15,000
+
economists care
$3,000
=
about
$37,000
$22,000
Capital Investment
Money that is
$40,000
tied up in tools
- equipment
John runs a small pottery firm. He hires one
helper at $12,000 per year, pays annual rent of
$5,000 for his shop and his materials costs
$20,000 each year. John has $40,000 of his
own money invested in equipment which could
earn him an estimated $4,000 per year if
otherwise invested. John has been offered
$15,000 per year to work as a potter for a
competitor. He estimates that his
entrepreneurial talents are worth $3,000 per
year. Hit total annual revenue from sales in his
shop is $72,000.
TR
Explicit
$72,000
$37,000
Implicit
$22,000
Accounting Profit = TR – Explicit Costs
$72,000 - $37,000 = $35,000
Capital Investment
$40,000
John runs a small pottery firm. He hires one
helper at $12,000 per year, pays annual rent of
$5,000 for his shop and his materials costs
$20,000 each year. John has $40,000 of his
own money invested in equipment which could
earn him an estimated $4,000 per year if
otherwise invested. John has been offered
$15,000 per year to work as a potter for a
competitor. He estimates that his
entrepreneurial talents are worth $3,000 per
year. Hit total annual revenue from sales in his
shop is $72,000.
TR
Explicit
Implicit
Capital Investment
$22,000
$40,000
$72,000 $37,000
Economic Profit = TR – Explicit Costs – Implicit Costs
-OR- Economic Profit = Accounting Profit – Imp Costs
$13,000
$35,000 - $22,000 =
John runs a small pottery firm. He hires one
helper at $12,000 per year, pays annual rent of
$5,000 for his shop and his materials costs
$20,000 each year. John has $40,000 of his
own money invested in equipment which could
earn him an estimated $4,000 per year if
otherwise invested. John has been offered
$15,000 per year to work as a potter for a
competitor. He estimates that his
entrepreneurial talents are worth $3,000 per
year. Hit total annual revenue from sales in his
shop is $72,000.
TR
Explicit
$72,000
$37,000
Implicit
$22,000
Capital Investment
$40,000
Important to Notice: the capital investments money
does not get touched!! It is tied into the business
until the business is sold…not considered a loss!!
Samuel has started a band and plans on touring the area
with his new rock band. It cost $25,000 for new
instruments, $4,000 a year to lease a van for
transportation, and $2,000 for advertising and a website.
Sam had to drain his savings account and sell his stocks
to buy the instruments, which was earning him $3,000 in
interest and dividends. Sam is of course the lead singer
and lead guitarist, but he is paying a bass player $300
per gig, his drummer $300 per gig, and his 2 back up
singers $200 each per gig. He books play dates for
$1,500 each and had 30 in their first year. By the way,
Sam was a pediatrician who earned $120,000 last year.
TR
$1500 ×
30 =
$45,000
Explicit
$4,000 +
$2,000 +
30($300 +
300 + 400)
= $36,000
Implicit
$3,000 +
$120,000 =
$123,000
Capital Investment
$25,000 for
instruments!!
Samuel has started a band and plans on touring the area
with his new rock band. It cost $25,000 for new
instruments, $4,000 a year to lease a van for
transportation, and $2,000 for advertising and a website.
Sam had to drain his savings account and sell his stocks
to buy the instruments, which was earning him $3,000 in
interest and dividends. Sam is of course the lead singer
and lead guitarist, but he is paying a bass player $300
per gig, his drummer $300 per gig, and his 2 back up
singers $200 each per gig. He books play dates for
$1,500 each and had 30 in their first year. By the way,
Sam was a pediatrician who earned $120,000 last year.
TR
$45,000
Explicit
$36,000
Implicit
$123,000
Capital Investment
$25,000
Sam’s Accounting Profit:
Sam’s Economic Profit:
$45,000 - $36,000 = $9,000
$9,000 - $123,000 = $114,000
He made a good accounting
decision!!
He made a terrible economic
decision.
Isabella has decided to change her career. She was getting fed up with
being a lawyer and working such long hours each day. She had a
salary of $75,000. Isabella’s passion is dogs and she wants to open
a doggie day care and grooming store. She had saved $35,000
from her previous job which she used to lease her location, hire two
part time employees, and toys and materials. If she were still a
lawyer that money would have earned her 10% interest in an
aggressive money market fund. It took some time, but she
managed to pick up quite a few clients who were willing to pay for
this normal good. She has earned $27,000 from her dog grooming
portion of her business. She also charges $50 per week for dogs to
come for daycare (where they get to play with other dogs, have
company all day, be walked and play outside). Her daycare
business is open for 50 weeks a year (the other two she is on
vacation) and she has fifteen committed clients.
TR
$27,000
+ (50 ×
15 ×
$50) =
$64,500
Explicit
$35,000
Implicit
$3,500 +
$75,000 =
$78,500
Capital Investment
Isabella has decided to change her career. She was getting fed up with
being a lawyer and working such long hours each day. She had a
salary of $75,000. Isabella’s passion is dogs and she wants to open
a doggie day care and grooming store. She had saved $35,000
from her previous job which she used to lease her location, hire two
part time employees, and toys and materials. If she were still a
lawyer that money would have earned her 10% interest in an
aggressive money market fund. It took some time, but she
managed to pick up quite a few clients who were willing to pay for
this normal good. She has earned $27,000 from her dog grooming
portion of her business. She also charges $50 per week for dogs to
come for daycare (where they get to play with other dogs, have
company all day, be walked and play outside). Her daycare
business is open for 50 weeks a year (the other two she is on
vacation) and she has fifteen committed clients.
TR
$64,500
Explicit
$35,000
Implicit
Capital Investment
$78,500
Isabella’s Accounting Profit:
Her Economic Profit:
$64,500 - $35,000 = $29,500
$29,500 - $78,500 = $49,000
She made a good accounting
decision!!
She made a terrible economic
decision.