Question

QUESTION 3

3.1 What does normal profit mean? Explain the difference between normal profit and economic profit.    3.2 Explain the relationship between average product and marginal product.

3.3 In economics we consider both explicit costs and implicit costs. Differentiate between implicit and explicit costs.

Answer 1

Profit is a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.

Definition of Economic Profit
Economic Profit also referred as extra profit or supernormal profit. It is the difference between total revenue earned by the company and the total costs (explicit as well as implicit). Explicit costs as explained above is the operating costs incurred while conducting the business activities. Implicit cost is the opportunity cost, i.e. the option forgone by the firm while investing the money somewhere else or using some other option. Implicit cost is also known as implied or imputed cost.

The economic profit is used by the economists to measure the financial position of the company. Along with that, it helps in forecasting the future performance. It works as a yardstick in judging the efficiency and effectiveness of the company’s profitability.

Definition of Normal Profit
Normal Profit is the minimum amount of profit required by the entity for its perpetual succession. When the economic profit equals zero (break even point) as a result of the difference between total revenue and total cost, normal profit arises. If the amount is greater (positive value) than zero, then economic profit arises. On the contrary, if the amount is lesser (negative value) than zero, then this is a state of economic loss.

Normal Profit equals to the implicit cost (opportunity cost) of the company. When the firm earns a normal profit, it means that it is earning enough earnings (i.e. Having sufficient money to pay off expenses) to keep the business going. It is just a measure used to judge the longevity of the company.

3.2 Marginal product focuses on the changes between production totals and the quantity of resources. Average product shows output at a specific level of input. The peak of the average product curve is the point at which the marginal product curve and average product curve intersect. For the points below (to the left of) this point, the marginal product of the extra input is higher than the average product. For example, if adding another worker increases output by more than the average product of the total labor force, then the marginal product of the new worker will raise the average product amount. Thus, the average product curve must be below the marginal product curve. Similarly, if the new worker adds less product than the average product amount, the average product curve will be above the marginal product curve (for all points to the right of the point of intersection of the two curves). At the point of intersection, the additional worker produces the same as the average product of the total workforce; there will be no change. The marginal product curve may fall to zero, showing that an additional worker will have no impact on production; for example, if there is no more space left to work in, or if machines are working at 100% capacity and all raw materials have been used up.

3.3

Implicit Cost vs Explicit Cost

Implicit and explicit costs are two types of costs that occur in a company. Both implicit and explicit costs come after a business transaction or activity. They can occur in any business activity like marketing distribution, production, or recruitment.

Explicit costs are costs that occur and are reported in business documents. They are also known as direct costs or accounting costs. An explicit cost is a cost that happens for a purpose. In addition, explicit costs usually have a direct impact on the company and its and profits. Explicit costs result in tangible assets or opportunities for the company. Examples of explicit costs are: payments for rent, salary and wages, services from other companies, raw materials, maintenance, bills, and other expenditures.

Explicit costs are easier to identify, recognize, and account for because they leave a record or paper trail. In addition, explicit costs usually involve physical objects and money-based transactions.

Explicit costs are used by accountants in preparing business analyses and business-related documents like accounting management and financial reports. For accountants, the explicit costs determine the company’s profit loss or gain. Explicit costs are used to provide a clear concept or picture of a company’s profit and performance. Aside from being used in reviewing profits and performance, explicit costs are also useful in financial planning or forecasting trends.

On the other hand, implicit costs are the direct opposite of explicit costs. Implicit costs are also called implied costs, economical costs, or notational costs. Implicit costs are not really shown or reported as costs.

Implicit costs are usually described as opportunity costs or the loss of an opportunity in a given time or situation. Implicit costs deal with intangibles that usually leave without a trace or record. Implicit costs include: wasted potential opportunities, time, profit, and labor. Implicit costs waive the potential benefits and satisfaction in a certain business transaction. Simply put, an implicit cost is the loss of a possible benefit or asset that did not occur.

Implicit costs can also be said to be the indirect results of business activities and processes. Usually, they involve indirect expenses from unforeseen events or emergencies. Since implicit costs leave no records, these costs are not easy to account for.

Economists use explicit costs to determine the economic profits of a business. Using implicit costs, economists can also determine the total costs of running a particular business. This is done by adding the implicit costs and explicit costs.

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