LEARNING OBJECTIVE
- Distinguish between economic profit and accounting profit
KEY POINTS
- Explicit costs are monetary costs a firm has. Implicit costs are the opportunity costs of a firm's resources.
- Accounting profit is the monetary costs a firm pays out and the revenue a firm receives. It is the bookkeeping profit, and it is higher than economic profit. Accounting profit = total monetary revenue- total costs.
- Economic profit is the monetary costs and opportunity costs a firm pays and the revenue a firm receives. Economic profit = total revenue - (explicit costs + implicit costs).
TERMS
The total revenue minus costs, properly chargeable against
goods sold.
A direct payment made to others in the course of running a
business, such as wages, rent, and materials, as opposed to implicit costs,
which are those where no actual payment is made.
The opportunity cost equal to what a firm must give up in
order to use factors which it neither purchases nor hires.
The difference between the total revenue received by the
firm from its sales and the total opportunity costs of all the resources used
by the firm.
EXAMPLES
- Consider a simplified example of a firm. In one year, it cost $60,000 to maintain production, but earned $100,000 in revenue. The accounting profit would be $40,000 ($100,000 in revenue - $60,000 in explicit costs). However, if the firm could have made $50,000 by renting its land and capital, its economic profit would be a loss of $10,000 ($100,000 in revenue - $60,000 in explicit costs - $50,000 in opportunity costs).
FULL TEXT
The term "profit" may bring images of money to
mind, but to economists, profit encompasses more than just cash. In general,
profit is the difference between costs and revenue, but there is a difference
between accounting profit and economic profit. The biggest difference between
accounting and economic profit is that economic profit reflects explicit and
implicit costs, while accounting profit considers only explicit costs.
Explicit and Implicit Costs
Explicit costs are costs that involve direct monetary payment.
Wages paid to workers, rent paid to a landowner, and material costs paid to a
supplier are all examples of explicit costs.
In contrast, implicit costs are the opportunity costs of factors of
production that a producer already owns. The implicit cost is what the
firm must give up in order to use its resources; in other words, an implicit
cost is any cost that results from using anasset instead of
renting, selling, or lending it. For example, a paper production firm may own a
grove of trees. The implicit cost of that natural resource is
the potential market price the
firm could receive if it sold it as lumber instead of using it for paper
production.
Accounting Profit
Accounting profit is the difference between total monetary
revenue and total monetary costs, and is computed by using generally accepted
accounting principles (GAAP). Put another way, accounting profit is the same as
bookkeeping costs and consists of creditsand debits on a firm's
balance sheet. These consist of the explicit costs a firm has to maintain
production (for example, wages, rent, and material costs). The monetary revenue
is what a firm receives after selling its product in the market.
Accounting profit is also limited in its time scope;
generally, accounting profit only considers the costs and revenue of a single
period of time, such as a fiscal quarter or year.
Economic Profit
Economic profit is the difference between total monetary
revenue and total costs, but total costs include both explicit and implicit
costs. Economic profit includes the opportunity costs associated with
production and is therefore lower than accounting profit. Economic profit also
accounts for a longer span of time than accounting profit. Economists often
consider long-term economic profit to decide if a firm should enter or exit a
market.
The biggest difference between economic and accounting
profit is that economic profit takes implicit, or opportunity, costs into
consideration.
Source: Boundless. “Difference Between Economic and Accounting Profit.” Boundless Economics. Boundless, 23 Mar. 2015. Retrieved 04 Apr. 2015 from https://www.boundless.com/economics/textbooks/boundless-economics-textbook/production-9/economic-profit-65/difference-between-economic-and-accounting-profit-245-12343/
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