MicroeconomicsLesson 1 of 1 in the course Production, Costs, and Industry Structure

Explicit and Implicit Costs: Accounting vs. Economic Profit

5 flashcards · 5 quiz questions · 5 match pairs · 5 fill-in sentences · English

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Summary

Businesses aim to earn a profit, but measuring profit requires more than adding up the bills a firm pays. This lesson explains how revenue and costs are defined, distinguishes explicit from implicit costs, and shows why accounting profit and economic profit can give different answers about a business’s success.

Profit=Total Revenue−Total Cost\text{Profit} = \text{Total Revenue} - \text{Total Cost}

All flashcards

What is total revenue?
The income a firm receives from selling its products; price multiplied by quantity sold.
What distinguishes explicit costs from implicit costs?
Explicit costs are direct out-of-pocket payments; implicit costs are opportunity costs of using resources the business already owns.
How is accounting profit calculated?
Total revenue minus explicit costs; it compares money received with cash payments made.
How is economic profit calculated?
Total revenue minus explicit and implicit costs; it includes the opportunity costs of resources used by the business.
What does negative economic profit tell an owner?
The business earns less than the value of the owner’s best alternative use of resources; this does not by itself mean the owner must close.

Quiz questions

  1. A business earns $200,000 in revenue, pays $50,000 in rent and $35,000 in wages, and its owner gives up a $125,000 salary. What is its economic profit?Answer: −$10,000
  2. Does negative economic profit by itself mean that a business owner must close the business?Answer: No; it means the owner earns less than the value of the best alternative use of resources.
  3. A business uses a building that its owner personally owns as a shop. How is the cost of using that building classified?Answer: An implicit cost
  4. An owner works extra hours in a business and gives up leisure time as a result. How may the value of that lost leisure be treated?Answer: As an implicit cost
  5. Can a business have positive accounting profit and negative economic profit?Answer: Yes; its implicit costs can exceed its accounting profit.

Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.

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