Profit (economics)

This article is about profit in economics and political economy. For profit in accounting and business, see Profit (accounting).

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Difference between how accountants and economists view a firm

In economics, profit is the difference between revenue that an economic entity has received from its outputs and total costs of its inputs, also known as surplus value.[1] It is equal to total revenue minus total cost, including both explicit and implicit costs.[2]

It is different from accounting profit, which only relates to the explicit costs that appear on a firm's financial statements. An accountant measures the firm's accounting profit as the firm's total revenue minus only the firm's explicit costs. An economist includes all costs, both explicit and implicit costs, when analyzing a firm. Therefore, economic profit is smaller than accounting profit.[3]

Normal profit is often viewed in conjunction with economic profit. Normal profits in business refer to a situation where a company generates revenue that is equal to the total costs incurred in its operation, thus allowing it to remain operational in a competitive industry. It is the minimum profit level that a company can achieve to justify its continued operation in the market where there is competition. In order to determine if a company has achieved normal profit, they first have to calculate their economic profit. If the company's total revenue is equal to its total costs, then its economic profit is equal to zero and the company is in a state of normal profit. Normal profit occurs when resources are being used in the most efficient way at the highest and best use. Normal profit and economic profit are economic considerations while accounting profit refers to the profit a company reports on its financial statements each period.

Normal profit = Total revenue – Total costs
Normal profit = Revenues – Total costs
Normal profit = Revenues – (Implicit costs + Explicit costs)

Economic profits arise in markets which are non-competitive and have significant barriers to entry, i.e. monopolies and oligopolies. The inefficiencies and lack of competition in these markets foster an environment where firms can set prices or quantities instead of being price-takers, which is what occurs in a perfectly competitive market.[4] In a perfectly competitive market when long-run economic equilibrium is reached, economic profit would become non-existent, because there is no incentive for firms either to enter or to leave the industry.[5]

  1. ^ Arnold, Roger A. (2001). Economics (5 ed.). South-Western College Publishing. p. 475. ISBN 9780324071450. Retrieved 14 April 2021. Economic profit is the difference between total revenue and total opportunity cost, including both its explicit and implicit components. [...] Economic profit = Total revenue – Total opportunity cost [...]
  2. ^ Cite error: The named reference EconDictionary was invoked but never defined (see the help page).
  3. ^ Mankiw, Gregory (2013). Principles of Economics. CENGAGE Lesrning.
  4. ^ Hubbard, Glenn; O'Brien, Anthony (2014). Essentials of Economics, Global Edition (4 ed.). Pearson Education Limited. p. 397. ISBN 9781292079172.
  5. ^ Lipsey, 1975. pp. 285–59.