Question

In 1 -2 pages, complete the following assignment: Explain the difference between implicit and explicit costs. Give two examples of when an explicit cost is different from an implicit cost. In your own words, explain the difference between accounting and economic profit. Give two examples of when they differ. Finally, explain the difference between economies and diseconomies of scale. Provide examples of when an actual firm might benefit from economies of scale or be harmed by diseconomies of scale.

Answer 1

1).

Implicit cost refers to the expense which has already been incurred but has not been recorded as a separate expense, => Implicit costs are not incurred directly by the company meaning that they are implied as no cash payment is involved. On the other hand, explicit costs are expenses which have been incurred and explicitly recorded as a separate expense.

Example explicit costs include the salaries and wages paid to the workers. This is different from an implicit cost where for example an owner of the business decides not to take any salary for services rendered.

The second example of an explicit cost is the cost of advertising which is incurred by the company during product promotion. This cost is different from the cost incurred by the firm to pay the rent of the business owner.

2).

Accounting profit is the difference between total revenue and explicit costs, => mathematically “Accounting Profit = TR-Total Explicit Cost”. On the other hand, economic profit is the difference between overall revenues and total expenditures including both the implicit and explicit costs, => mathematically “Economic Profit = TR -Total Explicit Cost -Total Implicit Cost”.

An example to differentiate the two involves a situation where an individual decides to start a business with an initial capital of $100,000. At the end of the year, he gets a profit of $150,000. Suppose we add an opportunity cost of $20,000 which represents his salary; the accounting profit will be equal to $150,000-$100,000 = $50,000. Economic profit in this case will be equal to $150,000-$100,000-$20,000 = $30,000.

Consider another example where a producer use two inputs “labor”

and “capital”. Now, after the production the producer gets “$100,000” as total revenue, where “labor” cost is given by “$25,000” and the capital cost is given by “$35,000”. So, here the “Accounting profit” is given by “$100,000-$25,000 = $75,000”, because here the producer own the “capital”, => producer don’t have to purchase it. Now, the economic profit is given by “$100,000-$25,000-$35,000=$40,000”.

3).

Economies of scale refer to an economic situation whereby an increase in production results in the decrease in unit cost or average cost. Diseconomies of scale refer to an economic concept where an increase in production results in increasing unit cost or average cost.

Firm for example supermarkets may benefit from economies of scale by purchasing in a large scale. Large scale purchases will enable the company to incur low average costs. On the other hand, poor means of communication within an organization may cost the company's decision-making process and result in more losses due to poor communication channels.