By

Mike Fladlien

Muscatine High School

Explicit and Implicit Costs for

Microeconomics

Total Revenue

The revenue received by a firm for the sale of its output. Total revenue is one two bits of information a firm needs to calculate economic profit, the other is total cost. In general, total revenue is the price times quantity--the price received for selling a good times the quantity of the good sold at that price. For a perfectly competitive firm, which receives a single unchanging price for all output sold, the calculation is relatively easy.

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P, Price

Q, Quantity

TR, Total Revenue

TR = PQ

If the price of a Greebie costs $1

and the firm sells 100 Greebies,

then total revenue equals $100

Explicit Costs

An opportunity cost that involves a monetary payment or some other form of compensation. The monetary payment is generally made to compensate the person who initially foregoes the satisfaction. This payment, in effect, transfers the burden of the opportunity cost from the original person to the one making payment. Explicit cost is also commonly termed out-of-pocket or accounting cost, and occasionally explicit opportunity cost.

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Explicit costs are payments made

to resources

Resources are:

Land

Labor

Capital

Capital is any good used to make

another good. Usually a machine,

tool, or building

Accounting Profit

The difference between the revenue received by a firm and the explicit accounting cost incurred. This is the profit listed on a firm's balance sheet, appears periodically in the financial sector of the newspaper, and is reported to the Internal Revenue Service for tax purposes. While accounting profit is the "standard" designation of profit used in the business world, economists prefer to use economic profit.

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Accounting Profit equals Total

Revenue minus explicit Costs

Example, a firm has $100 in total

revenue and the firm pays its

factors of production $50, then the

accounting profit is $50

The factors of production are

resources (Land, Labor, and

Capital.)

Implicit Cost of Labor

An opportunity cost that does not involve a monetary payment or any other form of compensation. The monetary payment that is often made to compensate the person who initially foregoes the satisfaction is not made for implicit cost. There is no payment to transfer the burden of the opportunity cost from the original person to someone else. Implicit cost is also occasionally termed implicit opportunity cost.

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The owner of the firm has alternate

uses for his or her talent. This is

the implicit cost of labor. As an

example, suppose that Juan works

as a teacher but could also paint

houses. The income Juan could

earn painting houses is the implicit

cost of Labor.

Implicit Cost of Capital

The implicit cost of

capital reflects the

income that could have

been earned if the

capital had been used in

its best alternative way.

Krugman’s Economics

for AP, page 532

Suppose Juan owns a restaurant.

The equipment in his restaurant

could be used to make pizzas. The

amount of the foregone revenue

Juan gives up to own and operate

his restaurant is an implicit cost of

captial.

Profit Economic Profit -- The difference between the total

opportunity cost of production and the total revenue received by a firm. Economic profit is what remains after ALL opportunity cost associated with production (including a normal profit) is deducted from the revenue generated by the production. Economic profit is one of three alternative notions of profit. The other two are accounting profit and normal profit.

Normal Profit -- The opportunity cost of using entrepreneurial abilities in the production of a good, or the profit that could be received by entrepreneurship in another business venture. Like the opportunity costs of other resources, normal profit is deducted from revenue to determine economic profit.

Zero Economic Profit is normal Profit

The Model

To understand how all

of this fits together, I

suggest the following

model.

Total Revenue

- Explicit Costs

= Accounting Profit

- Implicit cost of capital

- Implicit cost of Labor

Economic Profit

Economic profit can be positive,

negative, or zero

Three Cases of Profit

Case A Case B Case C

Total Revenue $100 $50 $40

Explicit Costs

Land 5.00$ 5.00$ 5.00$

Labor 10.00$ 10.00$ 10.00$

Capital 5.00$ 5.00$ 5.00$

Accounting Profit 80.00$ 30.00$ 40.00$

Implicits costs

Labor 20.00$ 20.00$ 20.00$

Captial 20.00$ 20.00$ 20.00$

Economic Profit 40.00$ (10.00)$ -$

A Comparison of the Three

Cases

Case A – The firm is making an economic profit.

This means that resources are employed over an

above their opportunity cost. This will attract

more competitors into the industry.

Case B – As firms find that the alternative uses

for their time are more profitable, they will exit the

industry.

Case C – The firm is employed efficiently

Questions?

Please email me: mfladlien@gmail.com

With suggestions

Questions

Comments

Please use this liberally