AP_Krugman_Textbook

What you will learn

in this Module:

530 section 10 Behind the Supply Curve: Profit, Production, and Costs

• The^ difference^ between
  explicit and implicit costs and
  their importance in decision
  making


• The^ different^ types^ of^ profit,
  including economic profit,
  accounting profit, and
  normal profit


• How^ to^ calculate^ profit

Module 52

Defining Profit

Understanding Oligopoly

The primary goal of most firms is to maximize profit. Other goals, such as maximizing

market share or protecting the environment, may also figure into a firm’s mission. But

economic models generally start with the assumption that firms attempt to maximize

profit. So we will begin with an explanation of how economists define and calculate

profit. In the next module we will look at how firms go about maximizing their profit.

In general, a firm’s profit equals its total revenue—which is equal to the price of the

output times the quantity sold, or P×Q—minus the cost of all the inputs used to

produce its output, its total cost. That is,

Profit =Total Revenue −Total Cost

However, there are different types of costs that may be used to calculate different types

of profit. To start the discussion of how to calculate profit, we’ll look at two different

types of costs, explicit costsandimplicit costs.

Explicit versus Implicit Costs

Suppose that, after graduating from high school, you have two options: to go to college

or to take a job immediately. You would like to continue your education but are con-

cerned about the cost.

But what exactly is the cost of attending college? Here is where it is important to re-

member the concept of opportunity cost: the cost of the time spent getting a degree is

what you forgo by not taking a job for the years you go to college. The opportunity cost

of additional education, like any cost, can be broken into two parts: the explicit costand

theimplicit cost.

Anexplicit costis a cost that requires an outlay of money. For example, the explicit

cost of a year of college includes tuition. An implicit cost, though, does not involve an

outlay of money; instead, it is measured by the value, in dollar terms, of the benefits

that are forgone. For example, the implicit cost of a year spent in college includes the

income you would have earned if you had taken a job instead.

A common mistake, both in economic analysis and in real business situations, is to

ignore implicit costs and focus exclusively on explicit costs. But often the implicit cost

Anexplicit costis a cost that involves
actually laying out money. An implicit cost
does not require an outlay of money; it is
measured by the value, in dollar terms, of
benefits that are forgone.