Explicit and Implicit Costs, and Accounting and Economic Profit

Transcription

1 OpenStax-CNX module: m Explicit and Implicit Costs, and Accounting and Economic Profit Alex Van der Merwe Based on Explicit and Implicit Costs, and Accounting and Economic Prot by OpenStax This work is produced by OpenStax-CNX and licensed under the Creative Commons Attribution License 4.0 By the end of this section, you will be able to: Abstract Explain the dierence between explicit costs and implicit costs Understand the relationship between cost and revenue Private enterprise, the ownership of businesses by private individuals, is a characteristic of the South African economy. When people think of businesses, often giants like Standard Bank, Sasol, MTN and Toyota SA come to mind. But rms come in all sizes. In fact the majority of private sector rms in South Africa employ less than 10 people (Schussler: 2012) which means that collectively they employ more people than the bigger rms. The biggest single cost for most rms is that of labor.,height!,height! Version 1.1: Nov 24, :55 am

2 OpenStax-CNX module: m Source: Statistics South Africa, 2016 Each of the businesses in these sectors, regardless of size or complexity, tries to earn a profit: % else, if it doesn't fit -48pt! Profit = Total~Revenue -- Total~Cost (1) % end of conditional for this bit of math Total revenue is the income brought into the firm from selling its products. It is calculated by m % else, if it doesn't fit -48pt! Total~Revenue = Price Quantity (2) % end of conditional for this bit of math

3 OpenStax-CNX module: m We will see in the following chapters that revenue depends on the demand for the firm's products. We can distinguish between two types of cost: explicit and implicit. Explicit costs are out-of-poc These two definitions of cost are important for distinguishing between two conceptions of profit, note: Consider the following example. Fred currently works for a big law firm. He is considering openi Step 1. First you have to calculate the costs. You can take what you know about explicit costs a % else, if it doesn't fit -48pt!

4 OpenStax-CNX module: m Office~rental : ~~ R60,000 Law~clerk's~salary : +R120,000 Total~explicit~costs : ~~~R180,000 (3) % end of conditional for this bit of math Step 2. Subtracting the explicit costs from the revenue gives you the accounting profit.

5 OpenStax-CNX module: m % else, if it doesn't fit -48pt! Revenues : R750,000 Explicit~costs : --R180,000 Accounting~profit : R570,000 (4) % end of conditional for this bit of math

6 OpenStax-CNX module: m But these calculations consider only the explicit costs. To open his own practice, Fred would ha Step 3. You need to subtract both the explicit and implicit costs to determine the true economic % else, if it doesn't fit -48pt!

7 OpenStax-CNX module: m Economic~profit = total~revenues~--~explicit~costs~--~implicit~costs = R750,000~--~R180,000~--~R580,000 = --R10,000~per~year (5) % end of conditional for this bit of math Fred would be losing R10,000 per year. That does not mean he would not want to open his own busi

8 OpenStax-CNX module: m Implicit costs can include other things as well. Maybe Fred values his leisure time, and startin Now that we have an idea about the different types of costs, let's look at cost structures. A firm 1 Key Concepts and Summary Privately owned firms are motivated to earn profits. Profit is the difference between revenues a 2 Self-Check Questions Exercise 1 (Solution on p.??-idm ) A firm had sales revenue of R1 million last year. It spent R600,000 on labor, R150,000 o

9 OpenStax-CNX module: m Exercise 2 (Solution on p.??-idm ) Continuing from Exercise 1, the firm's factory sits on land owned by the firm that could 3 Review Questions Exercise 3 What are explicit and implicit costs? Exercise 4

10 OpenStax-CNX module: m Would an interest payment on a loan to a firm be considered an explicit or implicit cost Exercise 5 What is the difference between accounting and economic profit? 4 Critical Thinking Questions Exercise 6 Some small family owned businesses such as corner cafés or shops, sometimes exist even t

11 OpenStax-CNX module: m Problems Exercise 7 A firm is considering an investment that will earn a 6% rate of return. If it were to bo References: Schussler, M Business owners in SA. Who, where, how big, what they do, and a few other facts. Ava Statistics South Africa Quarterly employment statistics (QES) December (Accessed: 24 Apr 2016) Statistical

12 OpenStax-CNX module: m Solutions to Exercises in this Module Solution to Exercise (p.??-idm ) Accounting profit = total revenues minus explicit costs =R1,000, (R600,000 + R150,000 Solution to Exercise (p.??-idp ) Economic profit = accounting profit minus implicit cost = R50, R30,000 = R20,000. Glossary Definition 1: accounting profit total revenues minus explicit costs, including depreciation Definition 2: economic profit total revenues minus total costs (explicit plus implicit costs)

13 OpenStax-CNX module: m Definition 3: explicit costs out-of-pocket costs for a firm, for example, payments for wages and salaries, rent, or materials firm Definition 4: an organization that combines inputs of labor, capital, land, and raw or finished component material Definition 5: implicit costs opportunity cost of resources already owned by the firm and used in business, for example, expanding Definition 6: private enterprise the ownership of businesses by private individuals production Definition 7: the process of combining inputs to produce outputs, ideally of a value greater than the value of the

14 OpenStax-CNX module: m revenue Definition 8: income from selling a firm's product; defined as price times quantity sold

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