Question

How does accounting profit differ from economic profit?

Answer 1

To understand the difference between accounting profit and economic profit, first note the difference in the two costs. Explicit costs by nature, are the payments made by firms to non-owners or the outsiders in exchange for resources and manpower. This includes wages and salaries, rent, lease payment, electricity bill, etc. They are paid explicitly and so they are not hidden or realized intangibly. Implicit costs, on the other side, are those monetary incomes that are sacrificed by the firm to conduct the business. These include the forgone salary of the owner if she has given up her job to do business. Basically, these are the opportunity costs of using the owner's resources which have been diverted from other activities Now the profit earned by the firm will be considered as accounting profit when the firm is deducing only the explicit cost out of the revenue earned. In case the implicit cost is also deducted from the revenue, the resulting amount will be either economic profit or loss. In this sense, when a firm earns economic profit, it is also earning accounting profit. The difference between these two profits matters to a business decision. In the long run most of the business are able to earn only normal or accounting profit. This is the amount required to stay in business. Those firms that are not able to earn enough accounting profit or are earning an accounting loss, leave the market. In this sense, accounting or normal profit is the necessary cost incurred by the firms to stay in market and maintain entrepreneur ability. A firm earning a negative economic profit can still stay in business. However, if the accounting profit is also negative, firm should not continue production and leave the industry in the long run.