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Chapter 8: Problem 3

Distinguish between a firm's explicit costs and its implicit costs and between a firm's accounting profit and its economic profit.

Short Answer

Expert verified
Explicit costs are direct, out-of-pocket expenses for a firm, while implicit costs are the indirect costs that represent the opportunity cost of resources. Accounting profit calculates the financial gain by subtracting explicit costs from revenue, whereas economic profit takes into account both explicit and implicit costs.

Step by step solution

01

Define Explicit Costs

Explicit costs are the direct, out-of-pocket expenses for a firm to produce goods or services. These costs are easily traceable to a product and include costs such as wages, rent, and materials.
02

Define Implicit Costs

Implicit costs are the indirect, non-outlay costs that represent the opportunity cost of using resources already owned by the firm. This can include things like the loss of potential interest on money spent on production, or the salary that the owner could earn elsewhere.
03

Define Accounting Profit

Accounting profit is the difference between revenue generated and explicit costs. It represents the profit that the firm has earned in monetary terms and it is reported on the firm's income statement.
04

Define Economic Profit

Economic profit takes into account both explicit and implicit costs. Therefore, it is the difference between revenue and the sum of explicit and implicit costs. A positive economic profit indicates that a firm is making more than enough to cover both its explicit and implicit costs, whereas a zero economic profit means the firm is just covering its total costs.

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