A firm’s accounting profit is always greater than its economic profit because:
a.
economic profit considers implicit costs, which accounting profit does not.
b.
accounting profit considers explicit costs, which economic profit does not.
c.
economic profit is always zero, no matter what kind of firm it is.
d.
accounting profit considers implicit costs, which economic profit does not.
e.
accounting profit is always positive, no matter what kind of firm it is.
The Correct Answer and Explanation is :
The correct answer is:
a. economic profit considers implicit costs, which accounting profit does not.
Explanation:
Accounting profit and economic profit are two distinct measures of a firm’s profitability. The key difference between them lies in how costs are treated.
- Accounting profit is calculated by subtracting only explicit costs (i.e., out-of-pocket expenses such as wages, rent, and materials) from total revenue. It is a measure of the actual monetary profit that a firm earns based on its direct, tangible costs. [
\text{Accounting Profit} = \text{Total Revenue} – \text{Explicit Costs}
] - Economic profit, on the other hand, considers both explicit costs and implicit costs. Implicit costs represent the opportunity costs of using resources in one way rather than another. For example, if the owner of a business could be working elsewhere or investing capital in another business, these potential earnings are implicit costs. Economic profit takes into account the full cost of all resources used, including those that do not involve direct payments (i.e., opportunity costs). [
\text{Economic Profit} = \text{Total Revenue} – (\text{Explicit Costs} + \text{Implicit Costs})
]
Since economic profit includes the implicit costs that accounting profit does not, it is generally lower than accounting profit. In many cases, a firm might report positive accounting profit but still have zero or negative economic profit when implicit costs are factored in. This means that even though the firm is making money, it could be doing less well than if it had chosen a different business or investment opportunity.
Thus, economic profit is always less than or equal to accounting profit because implicit costs (opportunity costs) reduce the total profit when considered.
Let me generate a simple image to visualize the differences.
Here’s an image illustrating the difference between accounting profit and economic profit. As you can see, accounting profit is higher because it only subtracts explicit costs, while economic profit is lower since it also accounts for implicit costs (opportunity costs). This shows how economic profit considers both types of costs, making it a more comprehensive measure of profitability.
