ECO 2023: Principles of Microeconomics
TOPIC: The Costs of Production
Putting “Meaning” on the Calculation of Economic Profits and Economic Losses
Before reading this handout, please review your Lecture Outline: V. A and B.
This handout should fill in the blanks from section C.
In Economics, the goal of a business owner is to MAXIMIZE Total Profit. Making some amount of profit is just
not good enough in the real world. You want to be in the line of business that allows you to make the best use of
your personal resources and earn the GREATEST AMOUNT of profit. This is the beauty of making the
Economic Profit (or Economic Loss) calculation! We now have a framework for considering alternative
business pursuits. This is stuff you’d be thinking about anyway, we’re just “formalizing” it!
In general, business owner will find himself/herself in one of three possible situations:
Situation #1: Earning an Above-Normal Economic Profit
This occurs for a business when Total Sales Revenue > Economic Cost during a given time period. This
tells the business owner that his/her current business endeavor is the best possible use of his/her
personal resources. Remember, implicit costs take into account the highest-valued alternative use of the
business owner’s personal resources. If your current business endeavor is able to generate enough Total
Sales Revenue to cover both your explicit and implicit costs, and then have money left over, then you’re
doing the “right thing” with your personal resources!
Situation #2: Earning a Normal Economic Profit
This occurs for a business when Total Sales Revenue = Economic Cost during a given time period. This
tells the business owner that his/her current business endeavor is doing just as well as the next best
alternative business endeavor would do. Your current business endeavor is able to generate just enough
Total Sales Revenue to cover both your explicit and implicit costs, with nothing extra left over. This
“normal profit” situation is essentially an indifference condition for a business owner. If I’m doing just
as well here as I could be doing there, then I’m content to stay right where I am doing what I’m doing.
Situation #3: Taking an Economic Loss
This occurs for a business when Total Sales Revenue < Economic Cost during a given time period. This
tells the business owner that there is something else out there s/he could be doing that would literally put
more money into his/her pocket. Your current business endeavor might be able to generate enough Total
Sales Revenue to cover your explicit costs, but it is unable to generate enough revenue to also cover
those all-important implicit costs. If there’s something out there that I could be doing that would put
more money into my pocket, then I probably need to be doing that instead of this!
Why do we care?
Real-world business decisions are made based on ECONOMIC MEASURES of PROFITS and LOSSES.