Download Profits Profits are determined by subtracting total costs from total

Profits Profits are determined by subtracting total costs from
total revenue.
Profit (P) = Total Revenue (TR) - Total Cost (TC)
The egg farm we have been looking at would appear to have
profits of $11,435 a month.
P = TR - TC
P = $110,500 - $99,065 = $11,435
However, this profit figure does not take into account some
economic costs to the owner of operating the farm. It does
not, for instance, take into account the managerial costs of
running the farm. Since the owner is the manager, unless he
pays himself a salary, the accounting profit figure overstates
the actual profitability of the business. Part of that $11,435
is really compensation to the owner for performing the
managerial functions of running the farm. If we assume that
the value of the management service provided by the
owner—the salary and benefits that would have to be paid
to someone else to manage the operation or the amount the
owner could earn managing some other egg farm—is $3,800 a
month, the profit figure is reduced to $7,635.
Another cost not included in computing the farm's profits is
a fair return on the money the owner has invested in the
business. If the investment in land, buildings, equipment,
and hens were financed with borrowed money, the interest
on the loan would appear as a fixed cost along with depreciation. But if the investment is the owner's own capital, which is
the case here, there is no actual interest payment.
Nevertheless, there is a cost to the owner of the capital tied
up in the business—an opportunity cost of the money which
could otherwise be earning a return on a loan to another
business or in some other investment.
The return calculated on the owner's invested capital
should be what the capital would earn on the average if put
into some other investment having the same degree of risk.
This expected return on the capital invested in the business is
the normal rate of return and is included as a cost when
determining the firm's economic profits.
The chicken farm has a capital investment of $710,000. If
the normal rate of return on investments with a similar
amount of risk is 15%, the monthly cost to the owner of having
his capital tied up in the chicken farm is $8,875. When this
is added to the other costs of the business, total costs are
greater than the revenue. The economic profits are a
minus—a loss of $1,240 a month. In effect, the owner is subsidizing the business with his labor and the use of his capital.
This is not unusual where proprietorships are concerned.
Small business owners frequently pay a price for being their
own boss.
profits the net returns after subtracting
total costs from total revenue. If costs are
greater than revenue, profits are negative.
normal rate of return the rate of earnings
on invested capital that is normal for a
given degree of risk. economic profits
earnings on invested capital that are in
excess of the normal rate of return.
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Case Application
Rising Costs Hit Rock Concerts
Rock concerts aren't drawing audiences as
they used to. Their decline in popularity may
have started with a tragedy in Cincinnati
when a stampede of fans to get into a concert resulted in the death of 11 people.
Whatever the reasons, there was a certain disenchantment with rock concerts and a decline
in the popularity of rock and roll in general.
Rock music now accounts for less than onethird of record sales.
The biggest names, such as the Grateful
Dead and the Rolling Stones, can still sell out
performances. But in the 1980s, many concert
promoters discovered that lesser-known
groups didn't draw well enough to cover expenses. Costs have greatly increased. The cost
of liability insurance, for example, to cover incidents like the one in Cincinnati, has multiplied many times over. If promoters have to
guarantee the performers $40,000, lay out
another $10,000 for rental of the arena, purchase liability insurance, rent sound and
lighting systems, and pay for radio and
newspaper advertisements, they face at least a
$70,000 outlay before they even start to sell
tickets. Performance costs such as hiring ushers, security guards, and the many ticket
checkers needed to counter widespread counterfeiting of concert tickets add to promoters'
expenses. They also have to pay the ticket
agencies a percentage of each ticket sold and
pay state taxes on the tickets.
The costs for a medium-size rock concert
are shown in Table 1.
With these high costs, it is not surprising
that promoters long for the "good old days"
when they could count on a rock concert to
fill the arena.
For Thought
1. What are the fixed costs shown for a rock
concert? What are the variable costs?
2. About how many tickets would the
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promoter have to sell at $15 each to cover the
above costs of a concert? 3. If the promoter
could only count on selling enough tickets
to cover those costs, do you think it would
be a good idea to go ahead and put on the
concert? Why or why not?
Table 1
COSTS OF A CONCERT
Expense
Cost
Performers
Arena rental
Insurance
Sound system
Lighting system
Radio time-buys
Newspaper ads
Personnel (ushers, etc.)
Ticket agency
State taxes
$40,000
10,000
4,500
2,700
1,450
8,600
4,300
2.10 per ticket sold
.75 per ticket sold
.90 per ticket sold