Total Revenue, Total Cost, Profit
Introduction
Generally, the goal of any firm is to maximize profit and the formula is as follows:
Profit = Total Revenue − Total Cost
Costs
There are two types of costs: Explicit and implcit
- Explicit costs need an expenditure of money such as rent, lease payments, and salaries.
- Implicit costs don't need expenditure of money. For example an opportunity cost that didn't involve an expenditure of money is an implicit cost.
Example
A firm has sales revenue of $2 million last year. The explicit costs include:Br>
- Salaries: $750,000
- Capital: $250,000
- Materials: $300,000
In addition, the firm's compound uses a land owned by the firm that could be rented at $50,000 per year.
Question : Calculate the explicit cost and the implcit cost.
Solution:
Explicit cost = $750,000 + $250,000 + $300,000 = $1,350,000
Implicit cost = $50,000
Accounting Profit versus Economic Profit
- Accounting profit = total revenue − total explicit costs
- Economic profit = total revenue − total costs
Example
In the previous example, calculate the the firm's accounting profit and economic profit.
Solution:
Accounting profit = Total Revenue − Explicit Costs = $2,000,000 − ($750,000 + $250,000 + $300,000) = 2,000,000 − $1,300,000 = $700,000
Economic profit = Total Revenue − Total Costs = $2,000,000 − ($750,000 + $250,000 + $300,000) − $50,000 = 2,000,000 − $1,350,000 = $650,000
Exercise
Exercise on Accounting Profit versus Economic Profit
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Solution to the Exercise on Accounting Profit versus Economic Profit
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Date of last modification: 2019