Understanding Profit in Microeconomics

GROSS PROFIT

Gross profit is the surplus which accrues to a firm when it deducts its total costs in producing products from its total income received from the sale of goods. In producing goods, a firm incurs explicit costs and implicit costs. In the ordinary language, the term profit is used in the sense of gross profit.

Gross Profit = Total Revenue – Total Explicit Costs

NET PROFIT

Net profit is the profit which accrues to an entrepreneur for his functions as an entrepreneur. These functions include risk bearing ability, innovating spirit, bargaining ability etc. Net profit is the reward of an entrepreneur for (i) organizing a business and undertaking risk (ii) his bargaining ability with the customers (iii) adopting new techniques of production (iv) monopoly gains if any (v) windfall gains due to sudden rise in the prices of goods.

Net Profit = Total Revenue – (Total Explicit Costs + Total Implicit Costs)

 ACCOUNTING PROFIT

This is the profit used by accountants to determine a firm’s taxable income. Explicit costs are the actual cash payments for resources purchased in resource markets. These are the rent paid on land and plant and equipment, wages to labor, interest on capital, cost of raw material, transport charges etc., etc. When all these explicit costs are subtracted from the firm’s total revenue, we get accounting profit.

Accounting Profit = Total Revenue – Explicit Costs

ECONOMIC PROFIT

“If a firm’s total revenue exceeds all its economic costs both explicit and Implicit, the residual which goes to the entrepreneur is called an economic or pure profit”.

Economic Profit = Total revenue – (Explicit Cost + Implicit Cost)

UNEMPLOYMENT RATE

The percentage of the total labor force that is unemployed but actively seeking employment and willing to work.

EMPLOYMENT-TO-POPULATION RATIO

A macroeconomic statistic that takes the ratio of the total working age of the labor force currently employed to the total working age population of a region, municipality or country

CONSUMER PRICE INDEX (CPI)

A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

GROSS DOMESTIC PRODUCT

The monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

GDP = C + G + I + NX

where:
“C” is equal to all private consumption, or consumer spending, in a nation’s economy
“G” is the sum of government spending
“I” is the sum of all the country’s businesses spending on capital
“NX” is the nation’s total net exports, calculated as total exports minus total imports. (NX = Exports – Imports)

QUANTITY THEORY OF MONEY

An economic theory which proposes a positive relationship between changes in the money supply and the long-term price of goods.  It states that increasing the amount of money in the economy will eventually lead to an equal percentage rise in the prices of products and services. The calculation behind the quantity theory of money is based upon Fisher Equation:

Calculated as:

M * V = P * T

Where:
M represents the money supply.
V represents the velocity of money.
P represents the average price level.
T represents the volume of transactions in the economy.

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