Question

1. Explain fully the differences between the terms below. You can use a numerical example to illustrate these differences.

   Explicit costs

   Implicit costs

   Accounting profits

   Economic profits

Answer 1

Explicit costs are expenditures of producer incurred on hiring factors of production from outside the business organisation. For example: Wages to labor, rent to the individual or organisation who provide their land to the business.

Implicit costs are expenditure done by the business organisation to hire factors of production provided by the owner of the organisation. It also includes the opportunity cost of the owner to engage in this business. For example: Profit or salary to the owner.

Accounting profits does not consider the implicit cost as the part of the total cost of the business.

Accounting profit= Total revenue-Explicit cost

Economic profit does include the both explicit as well as implicit cost of the business organisation.

Economic profit= Total revenue-Explicit cost-Implicit cost

Numerical example:

A person named John open his business by denying the job offer of $5000 per month. To open its business it will require $500 as rent for the building and to provide wages of $1000 per month. By estimation he observed that through the given resources he can produce and sell 200 units per month at a Price of $40.

Explicit cost= Rent + Wages= 500+1000= $1500

Implicit cost= Opportunity cost of opening an organisation= $5000

Accounting profit= 200 x $40 - 1500= 8000-1500= $6500

Economic profit= 200 x $40 - 1500-6000= $500