This is from the CFAI text, end of reading practice problems (pg 117). I found it peculiar and chalked it up to just a poorly written question but then noticed it was a 2005 Exam question! With regards to organizational structure and the calculation of costs and profits, which of the following statements is MOST ACCURATE? Compared to accounting costs, economic costs tend to be: A. Lower, especially for large firms organized as corporations B. Lower, especially for small firms organized as proprietorships C. Higher, especially for large firms organized as corporations D. Higher, especially for small firms organized as proprietorships I chose A, which is clearly not the correct answer… I’m interested to hear other’s answers and reasoning. I’m going to refrain from posting the solution since we now ALL own the books and can simply look up the correct answer in the back of the econ book.
Char-Lee, At first look, I would have gone with A as well so you are not alone in choosing it. Looking at it further, I am guessing C as there are higher cumulative implicit costs involved, due to higher capital and labor required to run a large corporation and thus higher economic costs. I would check the answer but don’t have my econ CFAI text in front of me.
Economic costs are usually always higher because they include not only explicit costs (accounting) but implicit costs as well (opportunity costs). Therefore, answer should be C or D. I would choose D because the opportunity cost of organizing a small company/proprietorship seems much higher than for a large corporation.
Economic costs are supposed to be higher than the accounting costs… so based on that I would choose either C or D (mostly D)… not sure which one though…
Jalmy8, you’re exactly right and I like your explanation. When I first read the question I incorrectly thought of economic cost as just implicit cost… when economic costs are both accounting AND opportunity together. So narrowing it down to C and D should have been easy. I’m still unclear why the econ cost are higher for a proprietorship, ALWAYS. Thanks though
Is it because their cost of capital is typically higher than large corps?
economic profit= total revenue-opportunity costs (p:94) opportunity costs=explicit costs +implicit costs (p:93) I guess they mean opportunity costs when they mention economic costs in the question. However, I have not seen the phrase “economic costs” used in the text.