Page 572 - Krugmans Economics for AP Text Book_Neat

What you will learn
in this Module:

• The difference between Module 52
explicit and implicit costs and
their importance in decision
making Defining Profit
• The different types of profit,
including economic profit,
accounting profit, and
normal profit
Understanding Profit
• How to calculate profit
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 costs and implicit 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 cost and
the implicit cost.
An explicit cost is 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
An explicit cost is a cost that involves
that are forgone. For example, the implicit cost of a year spent in college includes the
actually laying out money. An implicit cost
does not require an outlay of money; it is income you would have earned if you had taken a job instead.
measured by the value, in dollar terms, of A common mistake, both in economic analysis and in real business situations, is to
benefits that are forgone. ignore implicit costs and focus exclusively on explicit costs. But often the implicit cost

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