ACCOUNTING VERSUS ECONOMIC COSTS
The accountant's concept of cost has to do with historical cost, the cost the firm actually paid for when the firm purchased the product.
Managerial economists define the cost of producing a particular product as the value of the other products that the resources used in its production could have produced instead. The costs of inputs to a firm are their values in their most valuable alternative uses. These costs, together with the firm's production function (which indicates how much of each input is required to produce various amounts of the output), determine the cost of producing the product. These costs are called the opportunity costs. The opportunity costs may differ from the historical costs.
The difference between the accounting costs and the economic costs stems from the fact that the accountants are primarily concerned with measuring costs for financial reporting purposes, whereas the managerial economists are mainly concerned with measuring costs for decision-making purposes.
Accountants use explicit costs, examples of which would be costs of labor, raw materials, supplies, rent, interest, utilities and so on. An explicit cost is a cost that is incurred when an actual (monetary) payment is made.
Managerial economists use both the explicit and implicit costs, examples of which would be the opportunity costs of time and capital owned and used by the firm's owner. An implicit cost is a cost that represents the value of resources used in production for which no actual (monetary) payment is made.
Economists assume that the firm's objective is to maximize profits. Profit is the difference between total revenue and total cost.
Profit = Total revenue â" Total cost
Accounting profit = Total revenue â" Explicit costs
Economic profit = Total revenue â" (Explicit + Implicit costs).
Economic profit is usually lower (never higher) than accounting profit.