Page 447 - Economics

CONFIRMING PAGES

CHAPTER 20
379
The Costs of Production
Economic Costs A year after you open the store, you total up your ac-
counts and find the following:
Costs exist because resources are scarce, productive, and
have alternative uses. When society uses a combination of Total sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $120,000
resources to produce a particular product, it forgoes all Cost of T-shirts . . . . . . . . . . . . . . . . . . . $40,000
alternative opportunities to use those resources for other Clerk’s salary . . . . . . . . . . . . . . . . . . . . . . 18,000
purposes. The measure of the economic cost, or oppor- Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .5000
Total (explicit) costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,000
tunity cost, of any resource used to produce a good is the Accounting profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,000
value or worth the resource would have in its best alterna-
tive use. Looks good. But unfortunately your accounting profit of
We stressed this view of costs in our analysis of pro- $57,000 ignores your implicit costs and thus overstates the
duction possibilities in Chapter 1, where we found that economic success of your venture. By providing your own
the opportunity cost of producing more pizzas is the in- financial capital, building, and labor, you incur implicit
dustrial robots that must be forgone. Similarly, the oppor- costs (forgone incomes) of $1000 of interest, $5000 of rent,
tunity cost of the steel used in constructing office buildings and $22,000 of wages. If your entrepreneurial talent is
is the value it would have in manufacturing automobiles or worth, say, $5000 annually in other business endeavors of
refrigerators. The paper used for printing economics text- similar scope, you have also ignored that implicit cost. So:
books is not available for printing encyclopedias or ro-
mance novels. And if an assembly-line worker is capable of Accounting profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$57,000
assembling either personal computers or washing ma- Forgone interest . . . . . . . . . . . . . . . . . . . .$ 1 000
Forgone rent . . . . . . . . . . . . . . . . . . . . . . . . .5 000
chines, then the cost to society of employing that worker
Forgone wages . . . . . . . . . . . . . . . . . . . . . 22,000
in a computer plant is the contribution he or she would Forgone entrepreneurial income . . . . . . . . .5 000
otherwise have made in producing washing machines. Total implicit costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33,000
Economic profi t . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24,000
Explicit and Implicit Costs
Now let’s consider costs from the firm’s viewpoint. Keep- Normal Profit as a Cost
ing opportunity costs in mind, we can say that economic The $5000 implicit cost of your entrepreneurial talent in the
costs are the payments a firm must make, or the incomes it above example is a normal profit. As is true of the forgone
must provide, to attract the resources it needs away from rent and forgone wages, the payment you could otherwise
alternative production opportunities. Those payments to receive for performing entrepreneurial functions is indeed
resource suppliers are explicit (revealed and expressed) or an implicit cost. If you did not realize at least this minimum,
implicit (present but not obvious). So in producing prod- or normal, payment for your effort, you could withdraw
ucts firms incur explicit costs and implicit costs. from this line of business and shift to a more attractive en-
• A firm’s explicit costs are the monetary payments deavor. So a normal profit is a cost of doing business.
(or cash expenditures) it makes to those who supply The economist includes as costs of production all the
labor services, materials, fuel, transportation services, costs—explicit and implicit, including a normal profit—
and the like. Such money payments are for the use of required to attract and retain resources in a specific line of
resources owned by others. production. For economists, a firm’s economic costs are
• A firm’s implicit costs are the opportunity costs of the opportunity costs of the resources used, whether those
using its self-owned, self-employed resources. To the resources are owned by others or by the firm. In our ex-
firm, implicit costs are the money payments that ample, economic costs are $96,000 ( $63,000 of explicit
self-employed resources could have earned in their costs $33,000 of implicit costs).
best alternative use.
Example: Suppose you are earning $22,000 a year as a Economic Profit (or Pure Profit)
sales representative for a T-shirt manufacturer. At some Obviously, then, economists use the term “profit” differ-
point you decide to open a retail store of your own to sell ently from the way accountants use it. To the accountant,
T-shirts. You invest $20,000 of savings that have been profit is the firm’s total revenue less its explicit costs (or
earning you $1000 per year. And you decide that your new accounting costs). To the economist, economic profit is
firm will occupy a small store that you own and have been total revenue less economic costs (explicit and implicit
renting out for $5000 per year. You hire one clerk to help costs, the latter including a normal profit to the entrepreneur).
you in the store, paying her $18,000 annually. So when an economist says a certain firm is earning only

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