Is Economic Profit a Cost of Production - Essay Example

BUSINESS and ECONOMICS (Question and Answer) Distinguish between explicit and implicit costs, giving examples of each. What are the explicit and implicit costs of going to university Why does the economist classify normal profits as a cost Are economic profits a cost of production Explicit/Implicit Costs In the field of economics, there are major classifications of costs; two of these are explicit and implicit costs. Implicit cost come about when one gives up an option or a decision but does not make tangible payments for it. A classic example would be a night at the movies which naturally involves the expense of a moviegoer's ticket, popcorn and soda. However, the implicit cost would then be the compensation he/she would have earned if she/he had opted to work instead of seeing the movie. Basically, implicit costs are associated with the relinquished gains of any transaction. In its simplest form, an implicit cost takes place when the person misses out on satisfaction in search of an activity and is not compensated by money or any another form of fee; it starts and concludes with the act of foregoing the gains and satisfaction (McConnel and Brue 392-393). Another good illustration is when one decides to go to a university as a full-time student instead of working on a $20,000 job, this meant giving up earnings of $20,000. The potential earning being "sacrificed" is the implicit cost while explicit costs would be the books, basic tuition fees and laboratory charges, board and lodging and other conventional miscellaneous payments expected when taking a university education. On the other hand, explicit costs are the noticeable types of costs like rents, water and electric bill payments and expenditures on daily food maintenance (McConnell and Brue 410); in a business world scenario, these are the 'out of pocket' or cash expenditures a commercial enterprise incurs to outsiders who supply them resources. Normal Profit as Cost A business organisation is said to be making normal profit when total revenues equal aggregate expenditures. This takes place in situations of perfect competition when economic equilibrium is achieved. Economically speaking, normal profit is considered as a cost and acknowledged as one of the two elements of the cost of capital. Basically, this is the opportunity cost of employing consumerist capabilities in the creation or manufacture of a good or the profit that could be obtained by entrepreneurship in another commercial undertaking. Just like the opportunity costs of other resources, normal profit is subtracted from revenue to determine economic profit (Pyle and Larson 157-158). Since normal profit is economically a cost, there is no economic profit at equilibrium.. Is Economic Profit a Cost of Production Yes, by definition, economic profit is equivalent to the amount of output multiplied by the difference between the average cost and the price. This is what remains after all opportunity costs associated with production, are subtracted from the revenue generated by production. In a single-goods scenario, a positive economic profit occurs when the enterprise' average cost is below the value of the product or service at the profit-maximising output. Fundamentally, an economic profit crops up when its revenue surpasses the total (opportunity) cost of its inputs, noting that these outlays comprise the cost of equity capital that is gathered by normal profits (Albrecht 409). In essence, economic profit is the 'conceptually correct' idea of profit employed in economics, that is, if profit is revenue minus cost, then economic profit is the measure of profit. In the recession year of 1998, a lot of country A's residents who found themselves out of a job and short of money organised barter networks for goods and services. If such barter networks covered a significant quantity of goods and services, would measured GDP in 1998 be a good estimator of the actual value of goods and services produced during the year No, it will not be a good or an accurate estimator of the actual value of goods and services produced during the year. But first, what is GDP Gross Domestic Product or GDP is a rundown or an assessment used to evaluate the national well-being of a country in a quantified approach. In the U.S., the National Income and Product Accounts portray the correlation between income and product (output) and map out the major economic flows among the most important segments of the economy. As it is, GDP and other macroeconomic statistics have a considerable importance on governments' and businesses preparations for the future and the press and the public view these statistics as crucial signs of how well a country is doing (Fleming 62-65; Dentzer 67). GDP is assumed to appraise and determine the value of all final goods and services produced during the year. It must be noted that what is assessed are only "final goods and services," not all goods and services, because much of what is generated during the year, for instance, the battery that a car assembly plant sets up in an automobile, is consequently, in effect, resold, as part of another product; so to take account of this intermediate product would entail double counting; so, in essence, only final goods like the finished automobile that customers purchase for personal use are the ones counted. To elaborate a little further, the value of the purchased car to society is what is being paid for by the buyer, not what the car assembly plant shelled out for the battery and what the battery maker paid for the pieces it utilized in the manufacturing of the battery it produces, or what the car assembly plant paid for the tires and what the tire manufacturer disbursed for the rubber that the tires were made from. Likewise, those used car sales during the year are not taken into the calculation and this is because they were included in the period in which they were actually produced. Apparently, it can also be concluded that Gross Domestic Product does not include all final goods. Basically, GDP does not take into account household production since there is no practicable method to calculate how much of it is going on. Likewise, GDP also does not quantify the output of people producing illegal goods, such as the manufacture and sale of cocaine and illegitimate services, like sports betting. More significantly, barter transactions are also not counted because of the complexity in assessing and assigning value to these transactions. Why is the equality of marginal revenue and marginal cost essential for profit maximisation in all market structures Explain why price can be substituted for marginal revenue in the MR = MC rule when an industry is purely competitive. Profit maximisation is the process wherein the enterprise establishes the price and output level which provides the greatest profit. It can be identified by the contrast and relationship of marginal revenue and marginal cost. If marginal revenue is equal to marginal cost, then profit cannot be raised by altering levels of production. As it is, boosting production puts in more to cost than revenue, which means that profit will subsequently decline; conversely, a diminished production output takes off more from revenue than from cost, which means also a decline from profit (Roberts 837-841; Cliffton 137-151). Within the domains of neoclassical economics and microeconomics, perfect competition depicts a market in which buyers or sellers have no market power. These markets are customarily and creatively efficient. As a general rule, a perfectly competitive market is exemplified by the reality that no single commercial enterprise has influence on the price of the product it sells. A perfectly competitive market has numerous distinctive attributes which significantly includes: Many buyers/Many Sellers - in this scenario there are numerous purchasers with the eagerness and capability to buy a product at a certain price and there are several producers with the readiness and capacity to provide and make the product available at a certain price; Homogeneous Products - here, the products of different firms are exactly the same, for instance, salt; Low-Entry/Exit Barriers - with this situation, it is comparatively simple for a business to enter the market or make its exit; Perfect Information - provided for both buyers and producers; Enterprises Intend to Maximise Profits - here, the businesses seek to sell where marginal costs meet marginal revenue, where they generate the most profit. Hence, let us consider the outcomes if marginal revenue is not equal to marginal cost: If marginal revenue is bigger than marginal cost, like in the case for tiny amounts of output, then the business can increase profit by raising production; additional production puts in more to revenue than to cost, expectedly, profit increases; If marginal revenue is less than marginal cost, like in the case of big quantities of output, the enterprise can raise profit by lessening production; as it is, reducing production accordingly trims down revenue less than it reduces cost, so profit increases. Therefore, equality between marginal revenue and marginal cost is essential to the process of maximizing profit because if marginal revenue is equal to marginal cost, then the firm cannot increase profit by producing more or less output, profit then is maximised. Profit Maximisation - The Marginal Approach If total revenue and total cost figures are difficult to procure, this method must be employed. In this scenario, for each unit sold, marginal profit is equals marginal revenue minus marginal cost. Now, if marginal revenue is greater than marginal cost, marginal profit then is positive, or if marginal revenue is lesser than marginal cost, marginal profit will then be negative. However, when marginal revenue is equal to marginal cost, marginal profit is zero. Basically, since total profit rises when marginal profit is positive and total profit correspondingly dwindles when marginal profit is negative, it should arrive at a maximum where marginal profit is zero - or where marginal cost is equals marginal revenue. The reason for this is because the manufacturer or maker has accumulated positive profit up until the intersection of MR and MC -- where zero profit is gathered and any additional production will lead to negative marginal profit, because MC will be larger than MR. The meeting point of marginal revenue (MR) with marginal cost (MC) is shown in the illustration as point A. If and when the business is competitive, such as what has been depicted in the graph, the business looks at a demand curve (D) that is identical to its Marginal revenue curve (MR), and this is a horizontal line at a price arrived at by industry supply and demand. Average total costs are signified by curve ATC. Total economic profits are represented by areas P, A, B and C. Works Cited Albrecht, William P. Economics. Englewood Cliffs, New Jersey: Prentice-Hall, 1983 Clifton, J. A. "Competition and the Evolution of the Capitalist Mode of Production." Cambridge Journal of Economics, 1.2 (1977): 137-151 Dentzer, Susan. "The Growing Mysteries of the GDP." U.S. News and World Report October 30, 1995, p. 67. Fleming, Martin, "The Statistics Corner: The GDP Revisions and Understanding Sluggish Productivity Growth." Business Economics April 1996, pp. 62 - 65 Campbell R. McConnell and Brue, Stanley L. Economics: Principles, Problems, and Policies. McGraw-Hill Professional, 2005 Pyle, William and Larson, Kermit. Fundamental Accounting Principles. Homewood, Illinois: Richard D. Irwin, 1981 Roberts, J. "Perfectly and Imperfectly Competitive Markets." The New Palgrave: A Dictionary of Economics. 3 (1987): 837-41 Read More