digression: accounting profit vs economic profit accounting profit = total revenue - explicit cost...
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Digression: Accounting Profit vs Economic Profit
• Accounting Profit = Total Revenue - Explicit cost– Example: Self-employed C.P.A. who owns office
• Total revenue = $55,000• Supplies = ($2,000)• Accounting Profit = $53,000
• Accountants aged 35-45 earn around $65,000• Office space of like size rents for $13,000/yr
Accounting Profit vs Economic Profit
• Economic Profit = Total Revenue - Explicit Cost- Opportunity Cost
– Example: Self-employed C.P.A.• Total revenue = $55,000• Supplies = ($2,000)• Opportunity Cost
of Office = ($13,000)• Opportunity Cost
of CPA Time = ($65,000)Economic Profit = -$25,000
Examples of Explicit and Implicit Costs
Accounting Profit vs Economic Profit
• Normal Accounting Profit – may be around 10% of investment
• Normal Economic Profit – revenue covers explicit and opportunity cost– assumed to equal zero
• Returns have to cover the opportunity cost of the investment
For remaining lecture, we will refer to profit as economic profit
When should a firm go out of the business in the short-run?
1) When P = MC > ATC
Profit = P*Q - ATC*Q= (P - ATC)*Q > 0
Economic Profit > 0 Example P = 3, ATC = 2.054
Average and Marginal Costs
0.5
1
1.5
2
2.5
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3.5
4
4.5
5
0 100 200 300 400 500 600 700
Output
$
Marginal Cost
Avg Variable Cost
Avg Total Cost
Revenue = P*Q
Average and Marginal Costs
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
0 100 200 300 400 500 600 700
Output
$
Marginal Cost
Avg Variable Cost
Avg Total Cost
Total Cost = ATC*Q
Average and Marginal Costs
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
0 100 200 300 400 500 600 700
Output
$
Marginal Cost
Avg Variable Cost
Avg Total CostΠ П= (P-ATC)*Q
When should a firm go out of the business in the short-run?
2) When P = MC AVC < P < ATC = AFC + AVC
Profit = P*Q - ATC*Q = (P - ATC)*Q <0 (lose money)= {(P - AVC )- AFC}*Q> -AFC*Q = -FC
Keep producing in short run because better than swallowing FC, even though economic profit <0
When should a firm go out of the business in the short-run?
Example 2: AVC < P < ATC P = $1.75AVC = $1.55ATC = $1.83AFC = $0.28Q = 357
Profit = (P - AVC - AFC)*Q= (1.75 – 1.83)*357 = -$28.56 > -0.28*357 = -100$
Revenue
ATC > P > AVC
Total Cost
ATC > P > AVC
LOSS
ATC > P > AVC
LOSS with Shutdown
ATC > P > AVC
When should a firm go out of the business in the short-run?
3) When P = MC <AVC; P-AVC < 0
Profit = P*Q - ATC*Q= (P - ATC)*Q = {(P – AVC) – AFC}*Q< -AFC*Q = -FC
Stop producing in short run because swallowing FC is better than producing and losing even more
When should a firm go out of the business in the short-run?
Example 3: P = MC <AVCP = $1.25AVC = $1.50ATC = $2.00AFC = $0.50Q = 200
Profit = (P - ATC)*Q= (1.25 – 2.00)*200 = -$150 < -$100 = -FC
Revenue
Total Cost
Loss
Loss with Shutdown
When should a firm go out of the business?
SHORT RUN• Produce in the short run at P = MC when MC > AVC• Shut down when P < AVC
LONG RUN• In long run, need to make back fixed costs, so only
produce if P = MC >= ATC