Question

If accounting profits for a firm are 20% of output, and the opportunity cost of financial capital is 8% of output, then what do the firm's economic profits equal?

A. 6% of output
B. 10% of output
C. 12% of output
D. 8% of output

Answer 1

The firm's economic profits equal 12% of output.

Step-by-step explanation:

Economic profit is the difference between total revenue and total cost, which includes both explicit costs (such as wages, rent, and materials) and implicit costs (such as the opportunity cost of financial capital). Accounting profit only takes into account explicit costs. To calculate economic profit, we subtract the opportunity cost of financial capital from accounting profit.

In this case, accounting profit is 20% of output. The opportunity cost of financial capital is 8% of output. Therefore, the firm's economic profit would be 20% - 8% = 12% of output.