KRUGMAN'S

1
Defining Profit

• KRUGMAN'S
• MICROECONOMICS for AP

Margaret Ray and David Anderson
2
What you will learnin this Module

• 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.

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Understanding Profit

• Implicit versus explicit costs
• Accounting profit versus economic profit
• Normal profit

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I. Defining Profit

• Profit is equal to total revenue minus total cost
• Economists use the symbol p to represent profit
• p total revenue total cost
• p TR TC
• Total revenue equals the price paid times the
  number sold.
• TR P x Q

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II. Implicit versus Explicit Costs

• An explicit cost is a cost that involves actually
  laying out money.

• An explicit cost is a cost that involves actually
  laying out money.
• Examples include Rent, Wages, Interest on debt,
  depreciation and utility bills
• These are referred to as accounting costs
• An implicit cost does not require an outlay of
  money it is measured by the value, in dollar
  terms, of the benefits that are forgone.
• Businesses can face implicit costs for two
  reasons.
• A businesss capital could have been put to use
  in some other way.
• The owner devotes time and energy to the business
  that could have been used elsewhere.
• These are referred to as economic costs

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III. Accounting versus Economic Profit

• Accounting costs include only EXPLICIT costs
• Accounting profit equals total revenue minus
  total EXPLICIT costs
• Accounting p TR TC (explicit)
• Economic costs include BOTH explicit and implicit
  costs
• Economic profit is total revenue minus total
  costs (including both explicit and implicit
  costs)
• p TR TC (explicit implicit)

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IV. Normal Profit

• An economic profit equal to zero is known as a
  Normal profit
• A normal profit means that all costs (explicit
  and implicit) are covered by revenues.
• When a firm is earning a normal profit, it can do
  no better using resources in the next best
  alternative use.
• Example 
• If Betsy has zero economic profit, Betsy has sold
  enough clothing to
• 1. Pay all of her employees, insurance company,
  utilities, the bank, and her clothing suppliers.
  And!
• 2. Compensate her for all of the rental income
  she gave up and the Macys salary that she gave
  up.

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Profit Maximization

• KRUGMAN'S
• MICROECONOMICS for AP

Margaret Ray and David Anderson
9
What you will learnin this Module

• The principle of marginal analysis.
• How to determine the profit-maximizing level of
  output using the optimal output rule.

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Profit Maximization

• Both TR and TC are functions of output. As more
  output is sold (at a constant price), TR and TC
  both rise.
• The goal of the firm is to find the level of
  output where the economic profit is greatest
  (maximized).

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I. Marginal Analysis

• Marginal revenue is the additional revenue from
  selling one more unit of output.
• MR ?TR/?Q
• Marginal cost is the additional cost incurred
  from producing one more unit of output.
• MC ?TC/?Q
• Firms will continue to produce as long as MR gt MC
  and will stop producing when MC MR

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II. The Optimal Output Rule

• MC MR!

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III. Graphical Representation of Profit
Maximization
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IV. When is Production Profitable?

• So long as economic profit is greater than or
  equal to zero, the firm should continue to
  operate.
• If economic profits dip below zero (i.e. below a
  normal profit), the firm would consider
  permanently closing and moving resources to their
  next best alternative.

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The Production Function

• KRUGMAN'S
• MICROECONOMICS for AP

Margaret Ray and David Anderson
16
What you will learnin this Module

• The importance of the firms production function,
  the relationship between the quantity of inputs
  and the quantity of output.
• Why production is often subject to diminishing
  returns to inputs.

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Production Functions

• A production function shows the relationship
  between a firms inputs and output

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I. Inputs and Output

• Variable Inputs can be increased to increase
  production.
• Fixed Inputs cannot be increased in the near
  term to increase production.
• The short run versus the long run
• Short run at least one input is fixed. The
  time period that is too brief for a firm to alter
  its plant size (capital is fixed).
• Long run all inputs may vary. A period of
  time long enough for a firm to vary all inputs,
  including capital (plant size).

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II. Total Product

• Total Product (TP or Q) is the total output
  produced by the firm. A graph of the firms TP
  when it uses different levels of a variable input
  (with a given level of fixed inputs)is the firms
  production function.
• Total Product curves typically increase as the
  first workers are hiredworkers specialize etc.
  Eventually additional workers get in the way and
  total output falls.

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III. Marginal Product

• Marginal Product (MP) of an input is the
  additional output produced as a result of hiring
  one more unit of the input.
• Proper Labeling
• MPL (? Total Output)/(? Labor)
• MPC (? Total Output)/(? Capital)

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IV. Diminishing Returns

1. The shape of the TP curve illustrates the
   principle of Diminishing Returns to an Input.
2. Diminishing Returns to an Input as more and
   more of a variable input is added to a fixed
   input, the additional output produced will
   decline.

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Diminishing Returns
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Diminishing Returns
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Firm Costs

• KRUGMAN'S
• MICROECONOMICS for AP

Margaret Ray and David Anderson
25
What you will learnin this Module

• The various types of cost a firm faces, including
  fixed cost, variable cost, and total cost
• How a firms costs generate marginal cost curves
  and average cost curves

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From the Production Function to Cost Curves

• The previous module covered the production
  function and diminishing returns. In the short
  run, there are variable inputs and at least one
  fixed input. To hire inputs for production, the
  firm will incur production costs which we
  represent with cost curves.

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I. Total Costs

• Fixed costs (FC) are costs whose total does not
  vary with changes in output. These are the
  payments to the fixed inputs in the production
  function.
• Variable costs (VC) are costs that change with
  the level of output. These are the payments to
  the variable inputs in the production function.
• Total cost (TC) is the sum of total fixed and
  total variable costs at each level of output.
• TC FC VC

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II. Marginal cost

• MC is the additional cost of producing one more
  unit of output.
• MC ?TC/?Q ?(VC FC)/?Q ?VC/?Q

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III. Average Cost

• Average (AC) is the total cost divided by the
  level of output (it is also called average cost,
  unit cost, or per unit cost).
• ATC TC/Q
• AVC TVC/Q
• AFC TFC/Q
• Since TC TFC TVC,
• ATC AFC AVC

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IV. The relationship between MC and AC

• The MC curve intersects the U-shaped ATC and AVC
  at their respective minimum points.
• If the next (or marginal) value is above the
  average, it pulls the average up
• If the next (or marginal) value is below the
  average, it pulls the average down.
• Therefore
• The AC will fall as long as the MCltAC.
• As soon as the MC rises so that MCgtAC, the AC
  will begin to rise.
• If the MC of the next unit is equal to the
  current AC, AC will not change.