Final answer:
Accounting profit only considers explicit costs, while economic profit considers both explicit and implicit costs. Implicit costs are measured by quantifying the value of the best alternative use of resources. Normal profits reduce economic profits but not accounting profits.
Step-by-step explanation:
Accounting profit and economic profit differ in how they consider costs. Accounting profit only considers explicit costs, which are the actual out-of-pocket expenses incurred by a business, such as wages, rent, and materials. Economic profit, on the other hand, includes both explicit costs and implicit costs. Implicit costs refer to the opportunity costs of using resources in a particular venture, such as the foregone income from using those resources in an alternative investment.
Implicit costs are measured by quantifying the value of the best alternative use of the resources employed in a business. For example, if a business owner foregoes a salary of $50,000 per year to start their own business, that $50,000 is considered an implicit cost. It represents the income that could have been earned from an alternative employment. To measure implicit costs, one needs to assess the market value of the best alternative use of the resources.
One factor that can reduce economic profits but not accounting profits is the presence of normal profits. Normal profits refer to the minimum level of profits required for a business to stay in operation. It is the amount of profit needed to cover explicit and implicit costs and provide entrepreneurs with a return on their investment that is at least equal to what they could earn in their next best alternative. While normal profits are necessary for a business to continue operating in the long run, they do not contribute to economic profits because they represent the opportunity costs of using resources in the current venture.