13.3 - Economic Profit versus Accounting Profit

Accounting Profit (AP) =

AP = TR - EC

How does the amount of accounting profit compare to economic profit?

Accounting profit is usually larger than economic profit because the accountant ignores the implicit costs

13.3 CC Q4 A firm making positive ____ will stay in business by covering all its opportunity costs and has some revenue left to reward the firm owners. A) functions B) costs C) accounting profit D) economic profit

D Correct. A firm making positive economic profit will stay in business by covering all its opportunity costs and has some revenue left to reward the firm owners.

Economic Profit (EP) =

EP = TR - (EC + IC)

13.3 CC Q3 Explicit costs: A) are considered by economists and accountants when measuring a firm's profit B) do not enter into an accountant's measure of a firm's profit C) do not require an outlay of money by the firm D) are not an opportunity cost

A Correct. Explicit costs are costs that require an outlay of money by the firm. Both economists and accountants consider explicit costs when measuring a firm's profit.

13.3 CC Q1 Total revenue minus total explicit cost is: A) Accounting profit B) Economic profit C) Total cost D) Production function

A Correct. Total revenue minus total explicit cost is accounting profit.

13.3 CC Q2 Oscar owns an organic vegetable company. His accountant most likely includes which of the following costs on his financial statements? A) Forgone dividends that Oscar's money was earning in the stock market before Oscar sold his stock to purchase land to grow vegetables B) Wages Oscar could earn managing a supermarket C) Interest that Oscar's money was earning before he spent his savings on a delivery truck D) Cost of vegetable seeds

D Correct. Accountants include only explicit costs. Costs of vegetable seeds are explicit costs. Forgone interest, wages, and dividends are implicit costs.

Why does calculating the EP help determine whether a firm wants to stay in business or not (as opposed to calculating the AP)?

Economic profit is an important concept because it motivates the firms that supply goods and services. It is covering all its opportunity costs and has some revenue left to reward the firm owners. When a firm is making economic losses (EP is negative), the business owners are failing to earn enough revenue to cover all the costs of production. Unless conditions change, the firm owners will eventually close down the business and exit the industry.

13.3 CC Q5 Assuming that implicit costs are positive, economic profit is greater than accounting profit. T or F?

F Correct. Accounting profit equals total revenues minus explicit costs. Economic profit equals total revenues minus both explicit and implicit costs. Assuming that implicit costs are positive, accounting profit is greater than economic profit.

An economist measures a firm's economic profit as:

The firm's total revenue minus all the opportunity costs (explicit and implicit) of producing the goods and services sold

An accountant measures the firm's accounting profit as:

The firm's total revenue minus only the firm's explicit costs