Types of Profit- Old Version

Summary

In this video, Mr. Clifford explains the difference between accounting profit and economic profit, highlighting how businesses aim to maximize profit. Accounting profit only considers explicit costs, while economic profit includes both explicit and implicit (opportunity) costs. Using the example of LeBron James opening a taco shop, Mr. Clifford demonstrates that while accounting profit might show a positive gain, economic profit could show a loss when opportunity costs are factored in. He also explains the concept of zero economic profit, which represents a normal profit in competitive markets, where firms cover all costs and break even.

Takeaways

• 😀 Economists and accountants have different methods of calculating profit, and they often disagree.
• 😀 Accounting profit is calculated by subtracting explicit costs (out-of-pocket expenses) from total revenue.
• 😀 Explicit costs include things like wages, rent, and materials that businesses must pay for.
• 😀 Economic profit, on the other hand, considers both explicit and implicit costs (opportunity costs).
• 😀 Implicit costs represent the value of alternatives you forgo, such as potential earnings from other ventures.
• 😀 An example: If LeBron James opens a taco shop, his accountant would calculate a $1 million profit (Revenue - Explicit Costs).
• 😀 The economist, however, would subtract the $20 million opportunity cost of LeBron's foregone MBA salary, resulting in a $19 million economic loss.
• 😀 Economic profit gives a more realistic view of a business's financial situation, factoring in all opportunity costs.
• 😀 Zero economic profit doesn't always mean a business is doing poorly; it can mean the business is covering both its explicit and implicit costs.
• 😀 Zero economic profit is referred to as 'normal profit' in a competitive market, where firms can't make more profit elsewhere.
• 😀 In a competitive market, firms that make excess profit will attract competition, reducing their profits back to zero economic profit.

Q & A

What is the primary goal of every business according to the script?

The primary goal of every business is to maximize profit.

What are the two types of profit mentioned in the video?

The two types of profit mentioned are accounting profit and economic profit.

Why do economists and accountants dislike each other according to the script?

Economists and accountants dislike each other because they have different methods for calculating profit, with each group believing their method is correct.

What are explicit costs?

Explicit costs are out-of-pocket expenses that a business pays for, such as wages, rent, and materials.

How do accountants calculate profit?

Accountants calculate profit by subtracting explicit costs from total revenue.

What are implicit costs?

Implicit costs are the opportunity costs of what a business owner could be doing with their time or money, but they choose to invest in their business instead.

How do economists calculate economic profit?

Economists calculate economic profit by subtracting both explicit and implicit costs from total revenue.

In the example of LeBron James opening a taco shop, what is the accounting profit?

The accounting profit is $1 million, calculated by subtracting the explicit costs of $1 million from the total revenue of $2 million.

Why is LeBron's economic profit considered a loss even though his accounting profit is positive?

LeBron's economic profit is a loss of $19 million because, in addition to the explicit costs, the implicit cost of not being in the NBA (which is $20 million) is factored in.

What does zero economic profit mean, and is it a bad thing?

Zero economic profit means that a business's total revenue is equal to both explicit and implicit costs. It is not a bad thing because it implies the business is making just as much money as it would in its next best alternative.

What is the concept of 'normal profit' in a competitive market?

Normal profit is when firms in a competitive market break even, making zero economic profit. This means they cannot make more profit by doing something else, and it is considered a standard or expected situation in such markets.