Accounting profit is typically
a. greater than economic profit because the former does not take implicit costs into account.
b. smaller than economic profit because the former does not take implicit costs into account.
c. greater than economic profit because the former does not take explicit costs into account.
d. equal to economic profit because explicit costs include all opportunity costs.
The Correct Answer and Explanation is :
The correct answer is:
a. Greater than economic profit because the former does not take implicit costs into account.
Explanation:
In economics, the distinction between accounting profit and economic profit lies in how costs are treated.
Accounting profit refers to the profit a business makes after subtracting its explicit costs—these are the direct, out-of-pocket expenses like wages, rent, and materials. It is calculated as:
[
\text{Accounting Profit} = \text{Total Revenue} – \text{Explicit Costs}
]
However, accounting profit does not account for implicit costs. Implicit costs represent the opportunity costs of using resources in one way rather than the next best alternative. For example, if an entrepreneur uses their own time and capital to run a business, the implicit cost is the income they could have earned working elsewhere or investing their capital in another venture.
Economic profit, on the other hand, takes both explicit costs and implicit costs into consideration. It is calculated as:
[
\text{Economic Profit} = \text{Total Revenue} – \text{Explicit Costs} – \text{Implicit Costs}
]
Because accounting profit excludes implicit costs, it tends to be greater than economic profit. If a business has high implicit costs (such as the opportunity cost of the owner’s time), the economic profit will be much lower than the accounting profit, and in some cases, the economic profit could even be negative.
In summary, accounting profit is typically greater than economic profit because accounting profit only considers explicit costs, while economic profit factors in both explicit and implicit costs, giving a more comprehensive picture of a business’s profitability relative to its opportunities.
I’ll create an image to visually represent this distinction.
Here is the diagram comparing accounting profit and economic profit. It illustrates how accounting profit only considers explicit costs, while economic profit takes both explicit and implicit costs into account, making economic profit typically smaller than accounting profit. Let me know if you need any further explanations!
