Question

QUESTION

1. Demonstrate your knowledge of the difference between Economic and Business (Accounting) profit by showing relevant examples. You may use your own examples or cite examples from other sources. What are the advantages of computing economic profit?

2. Select your own firm or any firm that you are familiar with. Discuss the factors which have an influence on shareholders’ wealth. Identify managerial actions taken by the firm which are design to influence shareholder wealth.

Answer 1

Business or accounting profit only considers the explicit costs (i.e. the costs which are actually incurred in the course of doing business) and not implicit costs (i.e. opportunity costs which means the benefits foregone in order to conduct the business). So, accounting profits = total revenue - explicit costs.

Economic profit considers both explicit and implicit costs of a business. So, economic profit = accounting profit - implicit costs.

For example, if the total revenue is $100, total explicit costs = $50 and total implicit costs = $20.

Then accounting profit = total revenue - explicit costs = $100 - $50 = $50

And, economic profit = accounting profits - implicit costs = $50 - $20 = $30.

The advantage of Economic Profit

Economic profit reflects the true return of a business as it considers the opportunity costs as well. Opportunity costs are the benefits foregone in order to start a business. Therefore, by considering the implicit costs we know the real costs and profits of a business