Economic Costs Are Different From Accounting Costs

¶ … economic costs are different from accounting costs and why a firm might still operate even when there is a loss.

The best way to describe the differnce between economic costs and accounting costs is to break down the economic costs into explicit and implicit costs. 'Explicit costs" are all of those circumstances that require specific outlay of money such as paying employees, paying rent and utility bills.

"Implicit costs" on the other hand are those opportunities and potential profit or loss that oen may have made hade one gone in another direction, but due to having absorbed oneself in one's present business one had to forego. An example of this may be someone deciding not to look for a conventional job in order to start his own home business over the web. The conventional opportunity may have provided him with a certain profit that he now has to forgo being that he has chosen to sink his time and resources into a different direction. These are the costs that he has given up to pursue the alternative. He used the implicit costs of his time, money, and talents to invest them in his home business.

Accounting costs, on the other hand, look at the tangible profits and losses recorded by the business. Bookkeeping looks at the flow of funds that the business has recorded and is a mathematical enterprise that calculates and summarizes results of the business experience drawing summation and conclusion for government, business and shareholder's purpose as well as for potential investors who would like to know whether or not to invest in this industry. Accounting costs, in other words, focus solely on explicit costs and ignore implicit transactions.

Sometimes, ignoring implicit costs may, in actuality, reveal that the business is losing rather than succeeding. For instance, a person may have invested $55,0000 in an economics course. He dropped out of college (and still ahs the debt) to pursue a business that made a profit at $3,000. The accountant tells him that the bookkeeping shows the business to have been a success. Yet, were implicit costs to have been included, assessment would have concluded that the firm is operating a t a loss.

Some times, however, operating the business accords the individual more psychic pleasure and this is known as psychic income where even thoguh implicit cots may define loss, and implicit benefits are small, psychic pleasure accords him enough satisfaction to continue. The business owner may also look ahead to long-term opportunities and realize that even thoguh he may be running at loss of a profit right now, his costs and opportunities are variable in the future and that in the long run things can change. He may also realize that the firm is going through the Law of Diminishing Returns, namely that there are fixed costs (such as rent and utilities) that he has to pay. These drain his fledgling business, but once having gone through that, he may proceed further to overcome the stage of diminishing return (Chapter 3: production costs. http://www.peoi.org/Courses/mic/mic3.html).

******How does this article apply the marginal decision rule to the problem of choosing the mix of factors or production (capital intensive vs. labor intensive methods of production)? How do maquiladoras benefit the U.S. economy?

The marginal decision rule assumes that a business' goal is maximum profit. It recommends that the industry should expand production of and only I f the price is grater than the marginal cost. By the company increasing production, both cost of producing item and revenue increase. If the revenue exceeds cost, the firm makes a profit. If marginal cost (i.e. The cost of producing one more product) is less than the revenue gained, the company is recommended to go ahead and continue providing that service / products (expanding its production) since it will keep on making profit.

On the other hand, if the company finds that marginal cost exceeds revenue, the company should desist from expanding production.

In the case of Mexico's maquiladora industry this rule may be seen in their choice of mix of factors for production where when Mexico's maquiladora program began in 1965, most companies were assembly operations requiring unskilled labor. Today, the industry has evolved to the point where factories now use more sophisticated production techniques and require more skilled labor. In fact, in El Pasos they have put sophisticated programs in place where unskilled workers are trained to become skilled technicians. The marginal decision rule may be seen in this case in that, the firm has gradually adopted oen technology after the other only doing so once they realize that profit exceeds the enormous cost invested in turning unskilled workers into skilled technicians and with providing them the technology to become so. The firm has also provided benefits to America, in both exporting and importing to them and in boosting their own economy as well as in providing employment to Mexicans, In this way, it is reducing the immigrant problem whilst providing the U.S. with more business opportunities vis their trading with the U.S.

. The type of firm also plays a crucial role in how the firm makes a profit. Describe the characteristics of a perfectly competitive firm in your own words. What will happen to the profits of a perfectly competitive firm in the long run?

Perfect competition refers to the situation where no one specific company is large enough to have the power to set the price of a specific homogeneous product and each company sells identical products to a large number of buyers. The demand curve in this situation is perfectly elastic since any firm that raises its price will experience a zero demand since consumers, possessing perfect knowledge of the product, will transfer their attention to a firm that offers the identical product at the required price. If they make any profit, profit will be marginal and static. This is because there will be many individual buyers with none having control over the market price, and firms would be comprised of many small firms rather than featuring some oligarchic industries. Businesses would be able to enter and exit in a relatively easy manner thereby ensuring that all firms would make normal profits; buyers and sellers would incur no costs in making the transaction; the characteristics of the product stay static across the spectrum of suppliers; and there are sufficient firms in the industry that supply this product or service.

Compare the profit for the perfectly competitive firm to a monopoly in the long run. Why is it different?