A recent issue of Business Week reported the following: During the recent auto sales slump, GM, Ford, and Chrysler decided it was cheaper to sell cars to rental companies at a loss than to lay off workers. That’s because closing and reopening plants is expensive, partly because the auto makers’ current union contracts obligate them to pay many workers even if they’re not working. When the article discusses selling cars “at a loss,” is it referring to accounting profit or economic profit? How will the two differ in this case? Explain briefly.

Accounting profit is the profit after the accounting cost, including the sunk costs in the explicit costs. Economic profit is the extra revenue after explicit and implicit or opportunity cost.

The sunk costs are the ones that have already been invested and cannot be recovered.The sunk costs cannot be recovered because they have no alternative and zero opportunity cost.

Since the sunk costs cannot be recovered, these costs do not affect the economic decisions and are part of the direct costs.

Since the firms are obligated to pay the workers even if they are not working, the wages are sunk because there is no alternative way to use the labor or amount invested in the labor.

The firms’ profit will be the price received less the explicit or sunk costs.

Thus, selling the cars at a loss is the accounting profit where sunk costs (wages) are part of the accounting cost.

Since the sunk costs are part of the accounting cost, the accounting cost will be higher than the economic cost with no opportunity cost, and the rest of the explicit costs included in both are the same. Therefore, the accounting profit will be lower than the economic profit.