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By the end of this section, you will be able to:

  • Explain the difference between explicit costs and implicit costs
  • Understand the relationship between cost and revenue

Private enterprise , the ownership of businesses by private individuals, is a hallmark of the U.S. economy. When people think of businesses, often giants like Wal-Mart, Microsoft, or General Motors come to mind. But firms come in all sizes, as shown in [link] . The vast majority of American firms have fewer than 20 employees. As of 2010, the U.S. Census Bureau counted 5.7 million firms with employees in the U.S. economy. Slightly less than half of all the workers in private firms are at the 17,000 large firms, meaning they employ more than 500 workers. Another 35% of workers in the U.S. economy are at firms with fewer than 100 workers. These small-scale businesses include everything from dentists and lawyers to businesses that mow lawns or clean houses. Indeed, [link] does not include a separate category for the millions of small “non-employer” businesses where a single owner or a few partners are not officially paid wages or a salary, but simply receive whatever they can earn.

(Source: U.S. Census, 2010 www.census.gov)
Range in size of u.s. firms
Number of Employees Firms (% of total firms) Number of Paid Employees (% of total employment)
Total 5,734,538 112.0 million
0–9 4,543,315 (79.2%) 12.3 million (11.0%)
10–19 617,089 (10.8%) 8.3 million (7.4%)
20–99 475,125 (8.3%) 18.6 million (16.6%)
100–499 81,773 (1.4%) 15.9 million (14.2%)
500 or more 17,236 (0.30%) 50.9 million (49.8%)

Each of these businesses, regardless of size or complexity, tries to earn a profit:

Profit = Total Revenue – Total Cost

Total revenue    is the income brought into the firm from selling its products. It is calculated by multiplying the price of the product times the quantity of output sold:

Total Revenue = Price × Quantity

We will see in the following chapters that revenue is a function of the demand for the firm’s products.

We can distinguish between two types of cost: explicit and implicit. Explicit costs are out-of-pocket costs, that is, payments that are actually made. Wages that a firm pays its employees or rent that a firm pays for its office are explicit costs. Implicit costs are more subtle, but just as important. They represent the opportunity cost of using resources already owned by the firm. Often for small businesses, they are resources contributed by the owners; for example, working in the business while not getting a formal salary, or using the ground floor of a home as a retail store. Implicit costs also allow for depreciation of goods, materials, and equipment that are necessary for a company to operate. (See the Work it Out feature for an extended example.)

These two definitions of cost are important for distinguishing between two conceptions of profit, accounting profit and economic profit. Accounting profit is a cash concept. It means total revenue minus explicit costs—the difference between dollars brought in and dollars paid out. Economic profit is total revenue minus total cost, including both explicit and implicit costs. The difference is important because even though a business pays income taxes based on its accounting profit, whether or not it is economically successful depends on its economic profit.

Calculating implicit costs

Consider the following example. Fred currently works for a corporate law firm. He is considering opening his own legal practice, where he expects to earn $200,000 per year once he gets established. To run his own firm, he would need an office and a law clerk. He has found the perfect office, which rents for $50,000 per year. A law clerk could be hired for $35,000 per year. If these figures are accurate, would Fred’s legal practice be profitable?

Step 1. First you have to calculate the costs. You can take what you know about explicit costs and total them:

Office rental :    $50,000 Law clerk's salary : +$35,000 ____________ Total explicit costs :    $85,000

Step 2. Subtracting the explicit costs from the revenue gives you the accounting profit.

Revenues : $200,000 Explicit costs : –$85,000 ____________ Accounting profit : $115,000

But these calculations consider only the explicit costs. To open his own practice, Fred would have to quit his current job, where he is earning an annual salary of $125,000. This would be an implicit cost of opening his own firm.

Step 3. You need to subtract both the explicit and implicit costs to determine the true economic profit:

Economic profit = total revenues – explicit costs – implicit costs = $200,000 – $85,000 – $125,000 = –$10,000 per year

Fred would be losing $10,000 per year. That does not mean he would not want to open his own business, but it does mean he would be earning $10,000 less than if he worked for the corporate firm.

Implicit costs can include other things as well. Maybe Fred values his leisure time, and starting his own firm would require him to put in more hours than at the corporate firm. In this case, the lost leisure would also be an implicit cost that would subtract from economic profits.

Now that we have an idea about the different types of costs, let’s look at cost structures. A firm’s cost structure in the long run may be different from that in the short run. We turn to that distinction in the next section.

Key concepts and summary

Privately owned firms are motivated to earn profits. Profit is the difference between revenues and costs. While accounting profit considers only explicit costs, economic profit considers both explicit and implicit costs.

Problems

A firm is considering an investment that will earn a 6% rate of return. If it were to borrow the money, it would have to pay 8% interest on the loan, but it currently has the cash, so it will not need to borrow. Should the firm make the investment? Show your work.

References

2010 U.S. Census. www.census.gov.

Questions & Answers

where we get a research paper on Nano chemistry....?
Maira Reply
nanopartical of organic/inorganic / physical chemistry , pdf / thesis / review
Ali
what are the products of Nano chemistry?
Maira Reply
There are lots of products of nano chemistry... Like nano coatings.....carbon fiber.. And lots of others..
learn
Even nanotechnology is pretty much all about chemistry... Its the chemistry on quantum or atomic level
learn
Google
da
no nanotechnology is also a part of physics and maths it requires angle formulas and some pressure regarding concepts
Bhagvanji
hey
Giriraj
Preparation and Applications of Nanomaterial for Drug Delivery
Hafiz Reply
revolt
da
Application of nanotechnology in medicine
what is variations in raman spectra for nanomaterials
Jyoti Reply
ya I also want to know the raman spectra
Bhagvanji
I only see partial conversation and what's the question here!
Crow Reply
what about nanotechnology for water purification
RAW Reply
please someone correct me if I'm wrong but I think one can use nanoparticles, specially silver nanoparticles for water treatment.
Damian
yes that's correct
Professor
I think
Professor
Nasa has use it in the 60's, copper as water purification in the moon travel.
Alexandre
nanocopper obvius
Alexandre
what is the stm
Brian Reply
is there industrial application of fullrenes. What is the method to prepare fullrene on large scale.?
Rafiq
industrial application...? mmm I think on the medical side as drug carrier, but you should go deeper on your research, I may be wrong
Damian
How we are making nano material?
LITNING Reply
what is a peer
LITNING Reply
What is meant by 'nano scale'?
LITNING Reply
What is STMs full form?
LITNING
scanning tunneling microscope
Sahil
how nano science is used for hydrophobicity
Santosh
Do u think that Graphene and Fullrene fiber can be used to make Air Plane body structure the lightest and strongest. Rafiq
Rafiq
what is differents between GO and RGO?
Mahi
what is simplest way to understand the applications of nano robots used to detect the cancer affected cell of human body.? How this robot is carried to required site of body cell.? what will be the carrier material and how can be detected that correct delivery of drug is done Rafiq
Rafiq
if virus is killing to make ARTIFICIAL DNA OF GRAPHENE FOR KILLED THE VIRUS .THIS IS OUR ASSUMPTION
Anam
analytical skills graphene is prepared to kill any type viruses .
Anam
Any one who tell me about Preparation and application of Nanomaterial for drug Delivery
Hafiz
what is Nano technology ?
Bob Reply
write examples of Nano molecule?
Bob
The nanotechnology is as new science, to scale nanometric
brayan
nanotechnology is the study, desing, synthesis, manipulation and application of materials and functional systems through control of matter at nanoscale
Damian
Is there any normative that regulates the use of silver nanoparticles?
Damian Reply
what king of growth are you checking .?
Renato
What fields keep nano created devices from performing or assimulating ? Magnetic fields ? Are do they assimilate ?
Stoney Reply
why we need to study biomolecules, molecular biology in nanotechnology?
Adin Reply
?
Kyle
yes I'm doing my masters in nanotechnology, we are being studying all these domains as well..
Adin
why?
Adin
what school?
Kyle
biomolecules are e building blocks of every organics and inorganic materials.
Joe
how did you get the value of 2000N.What calculations are needed to arrive at it
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Antonio Reply
Suppose that a 5% increase in the minimum wage causes a 5% reduction in employment. How would this affect employers and how would it affect workers? In your opinion, would this be a good policy?
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Source:  OpenStax, Openstax microeconomics in ten weeks. OpenStax CNX. Sep 03, 2014 Download for free at http://legacy.cnx.org/content/col11703/1.2
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