Alright, so when we talk about cost, we're talking about the inputs, right? What does it cost us to create this output? What is the cost of the inputs into the production, right? And when we talk about cost, right? The revenues were the benefits to the firm? Well, the costs are going to be the costs to the firm, right? That sounds a little redundant, but right, we've been talking about benefits and costs pretty much throughout every unit that we've done in this course. So here I'm just clarifying that the benefits are going to be that revenue, and the cost is going to be the cost, right? So right now, we're going to define the cost between this explicit and implicit, okay? But after we do this, because we're going to do it this way to be able to calculate profit in certain ways, but after we do it this way, we're going to start talking about the cost in a different way. The reason we're doing this is that it's very common, easy exam questions where they ask us to calculate certain types of profit, accounting profit, and economic profit. And to do that, we need to talk about explicit and implicit costs. But like I said, after we learn how to calculate profit like this and do some practice, we're going to talk about costs in a whole different way again, alright? So this is one way to look at costs, and let's start here with explicit cost. So, an explicit cost is a cost that involves spending money, alright? So you're going to explicitly have this cost, right? Explicit is out in the open, right? And that's what explicit means, so you can tell how much this cost is, right? Because you're literally handing over money. So it's very easy to see that this cost exists because you've handed over money for it. Compare that to an implicit cost, right? It says here that they're non-monetary. These are going to be opportunity costs, right? Where there's no money being exchanged, you're not actually handing over money, but it is an opportunity cost, it's an opportunity that you gave up because you made this decision, right? Now, a quick note that these explicit costs, these are also opportunity costs, right? Because you had that money that you spent, right? You explicitly spent some money on something, but you could have spent that money on something else, right? So the opportunity cost there is that that money could have been spent somewhere else. So everything here is an opportunity cost, it's just that the implicit ones don't have actual money being spent. So let's talk about some examples about what is going to be this explicit or implicit cost, right? So we're going to talk about the idea of Elon Musk, right? The CEO of Tesla and SpaceX, he's a smart dude, and he's making tons of money, but what we didn't know about him is that he didn't care about all this tech stuff, all he ever wanted to do was open a bakery and just make some cakes, right? But instead, he started Tesla, he's exploring space, but in the back of his head, he's always thinking man, I wish I started that bakery. And now all of a sudden he's like, you know what, forget it all, I'm going to start the bakery. So what are some of the explicit costs that Elon Musk is going to have when he opens up Elon Musk cakes? Right? Well, he's going to have some standard stuff that he's going to spend money on like sugar for the cakes and flour, right? These kinds of standard things, right? You're going to see him spending money, right? He has to pay money for these things. He's going to have to pay wages, right? To his employees and rent, right? He's going to pay rent for something like that on the building that he's renting, right? These are all explicit because he's spending money, you can actually see the money going out, right? Compare that to some implicit costs of his business. So to him, one of the opportunity costs was this salary that he was making as CEO, right? He was making a salary as CEO of Tesla, and now he gave up that salary to start his bakery, right? So that salary is an implicit cost of this business. He gave up the opportunity to earn that salary when he opened the bakery, right? So he's going to have to consider that as an implicit cost of his business. Another very common one that they like to use in their examples is foregone interest. So foregone interest, when you buy capital investment. So let's say, Elon Musk had $300,000 in the bank that he took out to buy equipment, right? To bake his cakes. He bought ovens, he bought all sorts of equipment for his bakery, well that $300,000 that he took out of the bank, it was earning interest in the bank, right? There was some interest rate, and he was getting some money in interest for having that saved up. Now, when he took it out of the bank, he's no longer earning that interest, right? So he gave up that interest to start this business. So these are two of the most common implicit costs you're going to see, when you have to do practice problems is that this person is usually going to be skilled at something else, so they gave up a salary and when they start the business, they're going to have to take money out of savings, they're going to have to give up some interest, right? So that's what you're going to see generally when we talk about the implicit cost. Explicit costs are usually easier to see, right? It's going to be things that they're just spending money on. Cool? So a quick note here about these implicit costs before we move on is that there is a number amount, right? There was a dollar amount of his salary, right? Maybe he was making $300,000 as the CEO of Tesla that he gave up, but remember it's non-monetary. He didn't have to pay someone $300,000 when he quit the job and started the bakery, right? It's an opportunity cost because he didn't have to actually give up money for it, but it is something that he gave up not necessarily in cash. Cool? So let's go ahead and move on to the next video where we're going to define the different types of profit that we're going to be calculating. Cool. Let's do that now.
Revenue, Cost, and Profit: Study with Video Lessons, Practice Problems & Examples
Created using AIUnderstanding costs is crucial in economics, distinguishing between explicit costs, which involve direct monetary expenditure, and implicit costs, representing opportunity costs without cash transactions. Profit is defined as revenue minus costs, with accounting profit focusing on explicit costs and economic profit incorporating both explicit and implicit costs. Costs can further be categorized into fixed costs, which remain constant regardless of output, and variable costs, which fluctuate with production levels. Recognizing these distinctions aids in calculating average costs and understanding short-run versus long-run dynamics in business operations.
Step 1:Go to college. Step 2:Pass microeconomics. Step 3:??? Step 4:PROFIT
Explicit and Implicit Cost
Video transcript
Accounting Profit and Economic Profit
Video transcript
Alright, so right here at the bottom we've got profit. This is going to be the culmination of what we've discussed about revenues and costs so far. So, profit is going to be the difference between revenue and cost, right? So it's going to be revenue minus cost. And I want to make a quick distinction now because I've seen a lot of students struggle with the concept of revenue versus profit. Revenue is that money you're bringing in without regard to cost; it's all the total money that came in from sales, and then when you subtract the cost, what's left over is the profit, okay? So, revenue and profit are not the same thing. Revenue minus cost is going to equal our profit. We're going to calculate two types of profit in this class. The first one is our accounting profit. This is what an accountant might think of as profit. They're going to take the revenues and they're going to subtract the explicit costs—the things where we actually spent money. So that's going to equal our accounting revenue, just the revenue and the explicit cost, but us economists, right, we're going to take it a step further and we think about opportunity cost as well, right? So we're going to have revenues−explicit cost−implicit cost. That's going to be our economic profit, right? So the economic profit also takes into account these opportunity costs. Alright? So this is how we're going to define it; we're going to do some practice problems now where we're going to calculate accounting and economic profit in different situations, but remember, after this little lesson right now, we're going to keep talking about cost, but we're going to talk about it in a different light. We're going to redefine cost not as explicit or implicit, we're going to use different terms and different ways to think about it. Alright, so let's go ahead and do these practice problems about profit and then we'll keep going on about cost after that. Alright, let's go on and do that now.
Fast Fingers Freddy gives banjo lessons for $50 per hour. One day, he spends 8 hours planting $100 worth of seeds on his farm. If the seeds yield $600 worth of crops, what is his accounting profit and economic profit?
Ricky Smooth opens up a hunch punch stand in his dorm room every Wednesday for two hours. He spends $40 on ingredients and sells $120 worth of hunch punch. In those same two hours, Ricky could have been a nude model for the art department earning $60. Ricky Smooth has an accounting profit of ________ and an economic profit of ________.
Sweetie Nick has dreamt of owning a candy store his whole life. Unfortunately, after a few wrong turns, Sweetie Nick finds himself stuck in a job he hates, earning a nice salary of $100,000, but he is completely dead inside. One day, Sweetie Nick is fed up and decides to quit his job and open a candy store. He takes his $300,000 savings, which were earning 5% interest, and buys a property downtown. In his first year, Sweetie Nick sells $220,000 worth of candy that he purchased for $80,000. He also paid utilities of $2,000 and hired a cashier that earned $16,000 throughout the year. What is Sweetie Nick's accounting profit and economic profit?
Fixed Costs and Variable Costs; Short Run and Long Run
Video transcript
Alright guys, so like I said, now we're going to break up costs in a different way, right? Before, we were using explicit and implicit when we were going to calculate that profit, but now we are going to talk about costs as fixed costs or variable costs, okay? So fixed costs are costs that do not change as output changes. As we make more and more units, these fixed costs stay the same. They don't keep increasing as our output increases. Compare that to a variable cost, a variable cost is a cost that changes as output increases. Alright? And we're going to see some examples of that right now, but before we do that, I just want to say that when we talk about fixed costs, we're going to be using the acronym FC for fixed costs and for variable costs, VC for variable costs, right?
Total cost is going to be just the sum of fixed costs and variable costs, so it's just going to be fc+vc, right? Our total costs are going to be these fixed costs plus our variable costs. So let's go back to that idea of the Elon Musk case, right? He quit his job to start a bakery. So, what are going to be some of the fixed costs that Elon Musk Cakes is going to have? First, he's going to have the rent on the building, right? So if you think about the rent, let's say he pays $5,000 a month for his bakery, for the space where he has his bakery. Well, that $5,000 a month, it's not going to change based on how many cakes he makes, right? If he makes 1 cake or he makes 100 cakes, he's going to pay that same amount of rent regardless of how many cakes he makes that month, right? So that rent is a fixed cost, it's going to stay the same regardless of how many cakes he makes. Another one that's going to be a fixed cost is something like a bookkeeper's salary, right? If he hires a bookkeeper to take care of his business, that bookkeeper is going to make the same amount of money whether he's making 1 cake or he's making 100 cakes, right? That bookkeeper is going to make the same weekly salary regardless of what the output is of the company, right? So that salary is going to stay fixed regardless of output.
So let's consider some of the variable costs. Well, some of the variable costs are going to be those inputs that he puts directly into the cakes like sugar and flour, right? So sugar and flour are going to be some of our variable costs. You can imagine as he makes more and more cakes he’s going to need more sugar and more flour to make those cakes, right? So, it’s going to be things that are going up with the amount of output that you make, right? So things that increase with output. Another common one is day laborers, right? And we’re going to be dealing with this a little more, as we go on. So the idea of day laborers, right? As he makes more and more cakes, he’s going to need assistant chefs, right? So you would imagine that as he makes some cakes, he starts making some cakes he’s going to need an assistant. As he makes more and more cakes, he’s going to need more and more assistants helping him in the kitchen, right? So you'll see that these day laborers are variable cost, right? As he makes more and more cakes, he's going to need more and more of these day laborers to help him in the kitchen. Cool?
So that's the difference between these fixed costs and variable costs and now when we deal with these fixed costs and variable costs, most of the time we're going to be dealing with them as an average. The average fixed cost is going to be the fixed cost per unit. So to calculate an average cost all we need to do is just divide by the quantity, right? So we're going to have an amount of fixed costs and we're going to divide that by how many cakes we made, right? If there was that $5,000 fixed cost for the rent of the bakery, we can split that between how many cakes he made, right? How much of that fixed cost is it per cake? So we're going to have an average fixed cost which we're going to call AFC for 'average fixed cost', AVC for 'average variable cost', and very easy. Right? We're just going to have for fixed cost, it's going to be our fixed cost divided by quantity. For variable cost, it's going to be variable cost divided by quantity. And guess what? For total cost, well that's just going to be total cost divided by quantity. Right? But another way we could think about total cost, about our average total cost, is that we could just say that it's the average fixed cost plus the average variable cost. Either of those is also going to get us to our average total cost, right? Because up above, we define total cost as fixed cost plus variable cost. When we do a little bit of algebra, we'll see that this ends up being the same answer, right? So we can just take our total cost divided by quantity or if we have average fixed cost and average variable cost, we add those together to get average total cost. Cool?
One last thing to discuss, before we move on, we're going to be talking about two time periods in this class. There's going to be the short run and the long run. Okay? And there's not a very distinct definition of the short run; it's not 1 year, or 3 years, or 1 month. It’s going to be different for every business. The way we define the short run is the time period where at least one cost is fixed, okay? So if we have any fixed cost that means we’re in the short run, right? What could be something that is fixed? It could be the size of our factory, right? The factory size in the short run we’re basically stuck with this factory, right? We built a factory and we’re stuck with the constraint of this factory. We can only produce as much as this factory allows, right? So in the short run, that’s going to be fixed. Another thing that’s fixed is salaried employees, right? You might not be able to just fire these salaried employees in the short run, right? They’re going to be a fixed cost of the business.
So when we talk about the long run, compared to the short run, the long run is a time period where all costs become variable. So if you think in a long enough time period the size of the factory can be changed, right? If we think long enough maybe right now we’re stuck with this factory but eventually, we could demolish this factory, sell this factory, build a new one that’s bigger or build a new one that’s smaller, right? We can change the size of the factory. So, in the long run, the factory size ends up being variable, right? The amount we pay in rent becomes variable. Right now we might have a lease, that lease saying that we have to pay $5,000 a month for this bakery, but in the long run, that lease is going to expire, right? We don’t have that fixed cost anymore. We can reevaluate whether we want to have this current factory or want to build a new one. So we are going to be able to change the factory size in the long run, right? We can have that as variability, as a variable cost. Change factory size, and we'll be able to fire salaried employees. Right? If you in the long run, we’re going to be able to reevaluate everything about our business, we can fire people, we can change our factory size, we can take all those fixed costs and they'll be variable costs in the long run. Okay? So that's how we define time periods, right? It’s not a distinct amount of time, each business is going to have a different short run and a long run. It just depends on how long it takes you, to be able to treat your costs as variable costs, alright? So that's it, let's go ahead and move on to the next video.
A short run cost function assumes that:
A company currently has total costs of $4,096 when producing 128 units. If total fixed costs equal $1,024, what is average variable cost?
Rose incurs $7,200 per month in fixed costs operating her floral shop. She pays her employees $9 per hour and had three assistants working 120 hours this month. Her other variable costs were $800 this month. What are Rose's total variable costs and total costs this month?
Here’s what students ask on this topic:
What is the difference between explicit and implicit costs?
Explicit costs involve direct monetary expenditure, such as wages, rent, and materials. These costs are easily identifiable because they require actual cash outflows. For example, paying $5,000 in rent for a bakery is an explicit cost. Implicit costs, on the other hand, represent opportunity costs where no cash transaction occurs. These are the benefits foregone by choosing one option over another. For instance, if Elon Musk quits his CEO job to start a bakery, the salary he gave up is an implicit cost. Both types of costs are crucial for calculating economic profit, which considers both explicit and implicit costs.
Created using AIHow do you calculate accounting profit and economic profit?
Accounting profit is calculated by subtracting explicit costs from total revenue. The formula is:
Economic profit goes a step further by also subtracting implicit costs. The formula is:
For example, if a bakery has $100,000 in revenue, $60,000 in explicit costs, and $20,000 in implicit costs, the accounting profit would be $40,000, while the economic profit would be $20,000.
Created using AIWhat are fixed costs and variable costs?
Fixed costs are expenses that do not change with the level of output. Examples include rent and salaried employees. For instance, if a bakery pays $5,000 in rent, this cost remains the same whether it produces 1 cake or 100 cakes. Variable costs, on the other hand, fluctuate with production levels. These include costs like raw materials (sugar, flour) and day laborers. As the bakery produces more cakes, it will need more sugar and flour, increasing the variable costs. Understanding these distinctions helps in calculating total costs, which is the sum of fixed and variable costs.
Created using AIHow do you calculate average fixed cost, average variable cost, and average total cost?
Average fixed cost (AFC) is calculated by dividing total fixed costs by the quantity of output:
Average variable cost (AVC) is calculated by dividing total variable costs by the quantity of output:
Average total cost (ATC) can be calculated in two ways: by dividing total costs by the quantity of output or by summing AFC and AVC:
or
Created using AIWhat is the difference between the short run and the long run in economics?
The short run is a time period during which at least one cost is fixed. For example, a bakery might be stuck with a fixed rent for its building. In the short run, the size of the factory and salaried employees are considered fixed costs. The long run, however, is a time period where all costs become variable. Over a long enough period, the bakery can change its factory size, renegotiate rent, or adjust its workforce. The distinction between short run and long run helps businesses plan for immediate constraints and future flexibility.
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