Question

a. What is the difference between accounting and economic profit?

A firm had sales revenue of $1 million last year. It spent $600,000 on labor, $150,000 on capital and $200,000 on materials. If the firm’s factory sits on land owned by the firm that it could rent for $50,000 per year.

b. What was the firm’s accounting profit? Explain.

c. What was the firm’s economic profit last year? Explain.

Answer 1

A.

Accounting profit :

Accounting profit only considers explicit cost. Explicit cost refers as actual cost paid by firm.

Accounting profit =total revenue - explicit cost.

Economic profit :

Economic profit considers both explicit cost and implicit cost.

Implicit cost is opportunity cost that you have to forgone when you choose another option.

Economic profit =total revenue - explicit cost - Implicit cost

Or

Economic profit =accounting profit - Implicit cost.

B.

Accounting profit =total revenue - explicit cost

=10,00,000-9,50,000

=50,000.

Explicit cost refers as actual cost paid by firm.

Explicit cost =labor +capital +material

=6,00,000+150,000+200,000

=9,50,000.

Accounting profit only includes explicit cost.

C.

Economic profit =total revenue - explicit cost - Implicit cost

   =10,00,000-9,50,000-50,000

=0.

Implicit cost is opportunity cost that you have to forgone when you choose another option.

Here if owner not use the land of his own he could have earn 50,000 as rent but he choose another option so, it will be considered as implicit cost.