Question

Businesses employ resources to use in the production and sale of a good or service. Accounting profit is typically used as a way of evaluating the success of a business, but economists argue that economic profit is more relevant to determining whether a business should continue to operate. What is the difference between these two measures of profit? Explain why accounting profit is usually greater than economic profit.

Answer 1

Accounting profit only considers the cost that has actually happened, but economic profit considers those foregone profits also that could be earned as cost, along with the actually incurred costs. Hence, there is a difference between accounting profit and economic profit. Accounting profit only takes explicit or actual costs in consideration, but economic profit also considers the opportunity cost or implicit cost other than the explicit cost into the calculations. It makes the difference. Since economic profit is deducted by the implicit cost also, then it makes accounting cost to be greater than the economic cost.

For example a person does business and earn $100000 as accounting profit after deducting all the actual expenses. But, the person could have earned $20000 salary if he does not pursue the business  and it is an opportunity or implicit cost. This cost will be considered by the economic profit.

Now,

Economic profit = 100000 - 20000

Economic profit = $80000

As a result, accounting profit is greater than the economic profit.