Final answer:
Accounting profit is calculated by subtracting explicit costs from revenues, resulting in $115,000 for the provided example. To determine economic profit, both explicit and implicit costs are subtracted from revenues, revealing a loss of $10,000 per year.
Step-by-step explanation:
Understanding Accounting and Economic Profit
When computing a business's profitability, two important concepts must be considered: accounting profit and economic profit. Calculating the accounting profit involves subtracting the explicit costs from the revenues. In the provided example, the explicit costs total $85,000 and the revenues are $200,000, resulting in an accounting profit of $115,000. This is shown in the equation:
Revenues: $200,000
- Explicit costs: $85,000
Accounting profit: $115,000
However, to determine the true economic profit, one must also consider the implicit costs, which are not directly paid out in cash but represent the opportunity cost of using resources. If we factor in implicit costs of $125,000, the economic profit equation becomes:
Economic profit = total revenues - explicit costs - implicit costs
= $200,000 - $85,000 - $125,000
Economic profit: -$10,000 per year
This calculation shows that when considering both explicit and implicit costs, the business is actually operating at a loss, as indicated by the negative economic profit.