Consider the concepts of accounting profit and economic profit. Suppose you are a consultant and you are meeting with a business owner who is trying to decide whether to keep that business open or open a business in a different industry. Discuss the differences between accounting profit and economic profit and why it should matters in this circumstance.
Consider the concepts of accounting profit and economic profit. Suppose you are a consultant and you are meeting with a business owner who is trying to decide whether to keep that business open or open a business in a different industry. Discuss the differences between accounting profit and economic profit and why it should matters in this circumstance.
Profit is the surplus value that is generated in a process of production, which usually accrues to the owner of the business who undertakes the risk of economic activity and brings all factors together for the same. It is a financial benefit that is earned when the revenue from the sale of the output exceeds the cost of producing it.
A profit can be categorized either as accounting or economic. Accounting profit is the difference between total revenue and total explicit cost of production which is spent directly from the pocket. Economic profit, on the other hand, is calculated as the difference between total revenue and total cost of production, including explicit and implicit costs. If implicit costs are subtracted from accounting profit, the economic profit is derived.
To elaborate, the measurement of accounting profit only considers the expenses that are explicitly incurred in the process of production. These include payments made in cash to the factors of production which are outsourced, as well as overheads. When calculating economic profit, implicit costs are also taken into consideration which are the opportunity costs incurred when a business owner uses already owned assets and hence, lets go of the potential income which could have been generated from the asset in an otherwise activity.
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