Final answer:
To ascertain the economic success of Kelley Consulting, accounting profit and economic profit must be evaluated, with economic profit including implicit costs such as opportunity costs that are excluded from accounting profit.
Step-by-step explanation:
Understanding Accounting Profit and Economic Profit
To determine whether Deb Kelley's web consulting business, Kelley Consulting, is economically successful, it is vital to understand both accounting profit and economic profit. Accounting profit is the difference between total revenues and explicit costs—the tangible, out-of-pocket expenses. However, an accurate measure of profitability should also include implicit costs, such as the opportunity cost of the owner's time and potential salary from alternative employment.
Considering another example: Fred, who works for a corporate law firm, is assessing the profitability of opening his own legal practice. He expects an annual revenue of $200,000. After totaling his explicit costs ($85,000 for office rental and law clerk's salary), we subtract these from the revenues to calculate an accounting profit of $115,000 ($200,000 - $85,000). Nevertheless, to determine true profitability, Fred should consider his current salary of $125,000 as an implicit cost. Accounting for this would adjust his economic profit and potentially change his decision.
Net profit is simply the accounting profit less any additional implicit costs. The steps to calculate this involve firstly, totaling all explicit costs, and secondly, subtracting these costs from revenues to find the accounting profit. Then, subtracting the implicit costs from the accounting profit yields economic profit, which is necessary to make informed business decisions.