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Chapter 13: Problem 2

What is the difference between zero accounting profit and zero economic profit?

Short Answer

Expert verified
Zero accounting profit implies revenues equate to explicit costs and does not account for opportunity costs. Zero economic profit implies the firm is covering both explicit and implicit costs, indicating the firm is earning normal rate of return, hence it is indifferent between staying in business or using its resources elsewhere.

Step by step solution

01

Define Accounting Profit

Accounting profit is the total revenue minus explicit costs. Explicit costs are the actual out-of-pocket expenses for the input resources. When accounting profit is zero, that essentially means that the revenue generated equals the costs of goods sold.
02

Define Economic Profit

Economic profit is calculated by subtracting both explicit costs and implicit costs (opportunity costs) from total revenue. Opportunity costs represent the returns from the best forgone alternative. If economic profit is zero, this means that the company is making just enough to cover both explicit and implicit costs.
03

Comparison of Zero Accounting Profit and Zero Economic Profit

When accounting profit is zero, the firm is only covering its explicit costs and not its implicit costs. But when economic profit is zero, the firm is covering both explicit costs and implicit costs. This means the company is earning exactly the normal rate of return, which is the minimum amount needed to keep a company in its current business.

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Most popular questions from this chapter

In \(1916,\) Ford Motor Company produced 500,000 Model T Fords, at a price of \(\$ 440\) each. The company made a profit of \(\$ 60\) million that year. Henry Ford told a newspaper reporter that he intended to reduce the price of the Model \(\mathrm{T}\) to \(\$ 360\), and he expected to sell 800,000 cars at that price. Ford said, "Less profit on each car, but more cars, more employment of labor, and in the end we get all the total profit we ought to make." a. Did Ford expect the total revenue he received from selling Model Ts to rise or fall following the price cut? b. Use the information given above to calculate the price elasticity of demand for Model Ts. Use the midpoint formula to make your calculation. (See Chapter 6 , page \(186,\) if you need a refresher on the midpoint formula.) c. What would the average total cost of producing 800,000 Model Ts have to be for Ford to make as much profit selling 800,000 Model Ts as it made selling 500,000 Model Ts? Is this smaller or larger than the average total cost of producing 500,000 Model Ts? d. Assume that Ford would make the same total profit when selling 800,000 cars as when selling 500,000 cars. Was Henry Ford correct in saying he would make less profit per car when selling 800,000 cars than when selling 500.000 cars?

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