3.4 — Types of Profit

Accountants vs Economists

Accountants look at explicit costs which include out-of-pocket costs. This is mostly: payments made from firms for using resources of others, money going in and out.

Accountants use source documents (receipts) to calculate how much was purchased.

$\text{Accounting Profit}=\text{Total Revenue}-\text{Accounting Costs (Explicit Only)}$

Economists look at both explicit and implicit costs. Implicit costs are opportunity costs, which means considering the next best alternative the business could have invested its money into. For example: forgone wage, forgone rent, etc.

$\text{Economic Profit}=\text{Total Revenue}-\text{Economic Costs (Explicit + Implicit)}$

And also: $\text{Economic Profit}<\text{Accounting Profit}$ because economic profit always considers the implicit costs.

Normal Profit

Normal profit occurs when economic profit equals zero. This means the firm is covering all its explicit and implicit costs, including opportunity costs, but is not earning any additional surplus.

$\text{Normal Profit}=\text{Total Revenue}-(\text{Explicit Costs}+\text{Implicit Costs})=0$

In this case, the firm is breaking even in economic terms and has no incentive to leave or enter the market. All firms earn normal profits in the long run.

Positive and Negative Economic Profit

• Positive Economic Profit: Total revenue exceeds both explicit and implicit costs. This indicates the firm is earning more than its opportunity costs, attracting new firms in competitive markets.
• Negative Economic Profit (Economic Loss): Total revenue is less than economic costs. In this case, the firm may exit the market in the long run if losses persist.

Profit in Perfect Competition

In perfectly competitve markets:

• In the short run, firms may earn positive, negative, or normal profits.
• In the long run, economic profit tends to zero as firms enter or exit the market, achieving normal profit due to competition.