Lecture on Profit Types and Profit Maximization

Speaker: Jacob Reed from ReviewEcon.com

Introduction

• Topics: Different types of profit, profit maximization
• Resource: Total review booklet on ReviewEcon.com

Types of Profit

1. Accounting Profit

• Calculation: Total Revenue - Explicit Costs
  • Explicit Costs: Fixed and variable costs paid out of pocket

2. Economic Profit

• Calculation: Total Revenue - Explicit Costs - Implicit Costs
  • Implicit Costs: Opportunity cost of not choosing the next best alternative
• Normal Profit: Economic profit is zero, accounting profit equals implicit cost

Examples

Example 1: Teacher Turns Restaurant Owner

• Previous salary: $50,000
• Explicit fixed costs: $10,000
• Explicit variable costs: $12,000
• Total revenue: $30,000
• Accounting Profit: $30,000 - ($10,000 + $12,000) = $8,000
• Economic Profit: $8,000 - $50,000 = -$42,000 (Economic loss)

Example 2: Fast Food Worker Turns YouTuber

• Previous income: $35,000
• Explicit fixed costs: $5,000
• Explicit variable costs: $3,000
• Total revenue: $48,000
• Accounting Profit: $48,000 - ($5,000 + $3,000) = $40,000
• Economic Profit: $40,000 - $35,000 = $5,000 (Economic profit)

Example 3: Housekeeper Turns House Cleaning Service Owner

• Previous income: $38,000
• Explicit fixed costs: $1,000
• Explicit variable costs: $10,000
• Total revenue: $49,000
• Accounting Profit: $49,000 - ($1,000 + $10,000) = $38,000
• Economic Profit: $38,000 - $38,000 = $0 (Normal profit, breaking even)

Profit Maximization

• Objective: Determine optimal output level given costs and revenue
• Decision-Making: Based on marginal analysis (marginal revenue and marginal cost)

Graph Analysis

• Profit maximization occurs when the difference between total revenue and total cost is largest
• Points on the graph:
  • Total cost > Total revenue: Economic losses
  • Total cost = Total revenue: Breaking even
  • Total cost < Total revenue: Economic profits

Marginal Analysis

• Marginal Revenue (MR): Change in total revenue divided by change in quantity
• Marginal Cost (MC): Cost of producing one additional unit
• Profit Maximizing Rule: Produce until MR = MC

Examples of Finding Profit Maximizing Quantity

• Perfectly Competitive Firm: Produce where MR = MC
• Monopoly: Similar analysis, produce where MR = MC

Numerical Example

• Analyze total cost and revenue at different output levels
• Calculate marginal revenue and marginal cost for each level
• Determine profit maximizing quantity by comparing MR and MC for each unit of output

Conclusion

• Key point: Profit maximization involves producing where MR equals MC
• Practice resources: The Profit game on ReviewEcon.com, total review booklet for exam preparation

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End of Lecture