Question

Does accounting profit or economic profit determine how entrepreneurs allocate resources between different business ventures? Explain why.

Answer 1

Answer: Economic profit determines this.

Accounting profit = Sales revenue – All explicit costs (like direct material, electricity, salary payment, etc)

Economic profit = Accounting profit – All implicit costs or opportunity costs (like labor of owner, rent of owner’s land if was not paid, etc)

If economic profit is more than 0, the venture is highly profitable in terms of covering all expectations of owner and giving more of it. Therefore, allocating more resources towards that should give more benefits.

If economic profit is lower than 0, the venture can’t keep all the expectations of owner; therefore, resources are allocated there after the above allocation (if anything left).

Accounting profit can’t evaluate this thing.