Economics Micro & Macro (CliffsAP)

Part III: Microeconomics

Consider this example: suppose you work for a shoe store and you are earning $20,000 a year in wages. After some
time at the shoe store, you decide to become an entrepreneur and open your own shoe store. You invest about $30,000
in savings that had been earning you $1,000 in interest a year. Your new shoe store will be in a shopping center and will
cost you $8,000 a year in rent. You also hire someone to help you with the work at the shoe store, and you pay that indi-
vidual an annual salary of $15,000. You total up your accounting after a year in business, and here’s what you find:

Total Sales Revenue $150,000

Cost of Shoes $40,000

Clerk’s Salary $15,000

Building Utilities $6,000

Total Explicit Costs $66,000

Explicit Cost Profit $84,000

It would appear that your store is a success; however, you have not yet tabulated all the figures. You still haven’t consid-
ered the implicit costs, which need to be factored in to determine the pure profit. By using your own capital, building
space, and labor, you have created implicit costs. The implicit costs in this scenario are the $1,000 in interest you could
have earned with your savings account, the $20,000 a year in wages you gave up to be an entrepreneur, and the $8,000
a year in rent you’re paying:

Explicit Profit $84,000

Forgone Wages $20,000

Forgone Rent $8,000

Forgone Interest $1,000

Total Implicit Costs $29,000

Pure Profit = Explicit Profit – Implicit Costs = $55,000

Or Total Revenue – Economic Cost

Economic Profit: Short Run and Long Run

The term economic profitis used by economists to illustrate the pure profit or the profit that has all (both implicit and
explicit) the costs subtracted from it. Economists often gauge the value of a business venture by determining its total
costs. To determine total cost, however, you must first consider revenue. To determine revenue, you figure the number
of times your product is sold and multiply that number by the product’s price. Once you figure the revenue, you can
subtract your economic costs from it to derive your pure profit:

Revenue – economic costs = pure or economic profit

The demand for a firm’s product can fluctuate from time to time due to market and economic activities. When demand
changes, firms are left with no choice but to scramble and adjust to the changes in demand. The number of workers, raw
materials, and other resources employed can be easily adjusted to meet the demand of consumers. Firms can adjust these
resources in the short run to stabilize business. Other resources, such as building space and machinery, may take a longer
time to adjust. The difference in these periods of adjustment makes it necessary for economists to distinguish between
the long run and the short run.