Distinguish between implicit and explicit costs and give examples of each. In addition, explain how explicit and implicit costs affect the distinction between economic profit and accounting profit

Question

What explains the distinction between the two measures of profit?

Answer 1

Explicit costs are those that a firm pays out of pocket, i.e., for which monetary payments are made. In contrast, implicit costs are the opportunity of resources owned by the firm that are used in production but for which no explicit monetary payment is made. Examples of implicit costs include the cost of energy (electricity and natural gas) and payments made for labor services. Examples of implicit costs include the amount of money the owner of a firm could earn in his next best opportunity and the amount of rent the owner could receive from a building that he owns and uses in his own business. Generally speaking, accounting profit is calculated as the difference between total revenues and total explicit costs. In contrast, economic profit is calculated as the difference between total revenues and the sum of explicit and implicit costs.

Accounting profit is calculated to facilitate the determination of tax liabilities. Economic profit is concerned with the net return after all opportunity costs are accounted for.