What is the primary difference between accounting profits and economic profits?

• A. Economic profits are always higher than accounting profits because they include opportunity costs.
• B. Accounting profits include opportunity costs, whereas economic profits do not.
• C. There is no difference; both terms refer to the same concept.
• D. Accounting profits consider only explicit costs, while economic profits account for both explicit and implicit costs.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the definition of accounting profit. Accounting profit is calculated as total revenue minus explicit costs, where explicit costs are the direct, out-of-pocket expenses a firm incurs (e.g., wages, rent, materials).
2. Step 2: Understand the definition of economic profit. Economic profit is total revenue minus both explicit costs and implicit costs. Implicit costs represent the opportunity costs of using resources owned by the firm, such as the owner's time or capital.
3. Step 3: Recognize that accounting profit does not consider opportunity costs, while economic profit does. This means economic profit provides a more comprehensive measure of profitability by including what the firm sacrifices by not using resources in their next best alternative use.
4. Step 4: Compare the two profits. Since economic profit subtracts both explicit and implicit costs, it is usually less than or equal to accounting profit, never higher.
5. Step 5: Summarize the primary difference: accounting profit focuses only on explicit costs, whereas economic profit accounts for both explicit and implicit costs, reflecting the true economic value of the firm's decisions.