27.2 – Explicit and Implicit Costs, and Accounting and Economic Profit
27.2 – Explicit and Implicit Costs, and Accounting and Economic Profit
Learning Objectives
- Explain the difference between explicit costs and implicit costs
- Understand the relationship between cost and revenue
Private enterprise, the ownership of businesses by private individuals, is a hallmark of the U.S. economy. When people think of businesses, often giants like Wal-Mart, Microsoft, or General Motors come to mind. But firms come in all sizes, as shown in Table 1. The vast majority of American firms have fewer than 20 employees. As of 2020, the U.S. Census Bureau counted 6.1 million firms with employees in the U.S. economy. Slightly less than half of all the workers in private firms are at the 21,000 large firms, meaning they employ more than 500 workers. Another 32% of workers in the U.S. economy are at firms with fewer than 100 workers. These small-scale businesses include everything from dentists and lawyers to businesses that mow lawns or clean houses. Indeed, Table 1 does not include a separate category for the millions of small “non-employer” businesses where a single owner or a few partners are not officially paid wages or a salary, but simply receive whatever they can earn.
| Number of Employees | Firms (% of total) | Number of Employees | Annual Payroll |
|---|---|---|---|
| Total | 6,140,612 | 134.2 million | $7,565 billion |
| 0-4 | 3,828,482 (62.3%) | 6.0 million (4.5%) | $295 billion (3.9%) |
| 5–9 | 1,004,591 (16.4%) | 6.6 million (4.9%) | $265 billion (3.5%) |
| 10–19 | 638,663 (10.4%) | 8.6 million (6.4%) | $353 billion (4.7%) |
| 20–99 | 552,921 (9.0%) | 21.7 million (16.2%) | $979 billion (12.9%) |
| 100–499 | 95,000 (1.5%) | 18.7 million (13.9%) | $1,016 billion (13.4%) |
| 500 or more | 20,955 (0.3%) | 72.6 million (54.1%) | $4,657 billion (61.6%) |
| (Source: U.S. Census, 2020 SUSB Annual Data Tables by Establishment Industry (census.gov)) |
Each of these businesses, regardless of size or complexity, tries to earn a profit:
[latex]\text{Profit}=\text{Total Revenue}-\text{Total Cost}[/latex]
Total revenue is the income brought into the firm from selling its products. It is calculated by multiplying the price of the product times the quantity of output sold:
[latex]\text{Total Revenue}=\text{Price}\times\text{Quantity}[/latex]
We will see in the following chapters that revenue is a function of the demand for the firm’s products.
Orthodox economists distinguish between two types of cost: explicit and implicit. Explicit costs are out-of-pocket costs, that is, payments that are actually made. Wages that a firm pays its employees or rent that a firm pays for its office are explicit costs. Implicit costs are more subtle, but just as important. They represent the opportunity cost of using resources already owned by the firm. Often for small businesses, they are resources contributed by the owners; for example, working in the business while not getting a formal salary, or using the ground floor of a home as a retail store.
These