Learning about economic costs and economic profit reminded me of my first time attempting to make a profit from selling goods — in middle school at the Holiday Faire. Most of us have probably either sold something at a Holiday Faire or have purchased something from a student-run Holiday Faire, so I thought using it as an example would be a helpful way to illustrate explicit costs, implicit costs, and economic profit.
First let’s define explicit and implicit costs. Explicit costs are the monetary costs of goods and services required to produce goods or supply services. Supposing you were planning to sell custom T-shirts at the faire, the implicit costs would include how much money your parents requested in exchange for their help, the cost of the T-shirts and the shipping of those T-shirts, and the downpayment the school required in order to have a booth at the faire. On the other hand, implicit costs are the opportunity costs of using self-owned, self-employed resources. Therefore, implicit costs would include how much money you would have received had you kept the money that you spent on explicit costs in the bank (forgone interest), how much money you would have received babysitting or mowing lawns (forgone wages), and how much money your ideas were worth (forgone entrepreneurial income).
Now let’s calculate your accounting profit and your economic profit. In order to find your accounting profit, you must subtract your explicit costs from your total sales revenue. Assuming you make $200, but your mom demanded $5 for her help, the T-shirts originally cost $100, shipping cost an extra $5, and the school tok $20 for themselves, you would have $70 of accounting profit. (Think about how many hot pockets you could’ve bought from the student store!) But if you continued on to calculate your economic profit, you must subtract your economic costs, both explicit and implicit, from your total revenue. Since we’ve already subtracted explicit costs from your total revenue, we now have to subtract the implicit costs. These included $2 of forgone interest, $20 of forgone wages, and $20 of forgone entrepreneurial income. This resulted in $28 of economic profit. (Not as many hot pockets now!)
You may not have made much money, but perhaps selling T-shirts at the Holiday Fair maximized your utility regardless. After all, selling goods at the Holiday Faire was much more about skipping class than it was about making profit.
This is a really good example for describing economic profit and details very clearly the different parts to consider when calculating your total! While a product's sales may be high, profit is what really matters and you want to be able to maximize it by producing at a low cost. You also touched on implicit profit which is a complicated topic and you clearly explained that it is the opportunity cost you take when are selling one product when you could be selling the other.
ReplyDeleteI thought this was a very clear and effective explanation of these economic concepts. It kind of made me consider the difference between the long and short run. Since, during the time of the holiday faire is pretty short, students don't have time to react and change the amount of goods they produce. For most products, the supply is perfectly inelastic, which is pretty rare to see in the market. This makes it all the more important for producers to estimate the demand curve and set the right price for the equilibrium price (Although most of us didn't succeed and had to sell our products at a loss by the end of the faire).
ReplyDeleteGreat post Adrienne! This really helped me to better understand how to calculate an accurate economic profit. This also helps me to understand how to calculate my prices for the business that I run out of my parent's kitchen much better, it is similar to the holiday faire in the sense that I have to pay for ingredients and such. Thanks for such an informative post!
ReplyDeleteI think that this was a really cool application of what we've been learning this unit! It's interesting to look back and see that we have already used economics in our life, without even knowing it. These calculations are very crucial to a strong business model, and are thus very important to any of us who plan to, at one point or another, start a business or even just sell any kind of product.
ReplyDeleteI really liked your example that you used to explain implicit and explicit costs. I found it really relatable since most of us have participated in holiday fairs previously. I thought that your explanation was clear and easy to understand since you you clearly stated the process that you went through and how the profits and revenues progresses.
ReplyDeleteThis post about economic profit and costs makes sense. I have never participated in selling something in the Holiday Faire before, but several of my friends have. They had a similar experience to this in that they wanted to make a profit economically, but that was not the main reason they chose to sell something in the Holiday Faire. It may not be the best decision economically as there are many costs as you mentioned, but the experience adds to the total utility you get.
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