When most people think about the term “profit,” they are thinking about accounting profit. However, economists also think about the idea of economic profit. This is different from accounting profit. It is bad for a company to make zero accounting profit, but it is okay for it to make zero...
When most people think about the term “profit,” they are thinking about accounting profit. However, economists also think about the idea of economic profit. This is different from accounting profit. It is bad for a company to make zero accounting profit, but it is okay for it to make zero economic profit in many circumstances.
Accounting profit is the familiar kind of profit. You figure accounting profit by subtracting costs from revenues. If a business makes zero economic profit, it is only bringing in enough revenue to cover its costs. This business will not lose money, but it will not make money for the people who own it. This is not a good thing.
Economic profit takes into account a type of costs that most people do not think about. This type of cost is called “implicit cost.” To find economic profit, you first find accounting profit. Accounting profit takes into account only explicit costs. These are costs (like the cost of labor and materials) that the business actually pays out to other people. Once you have found your accounting profit, you must then subtract your implicit costs. These are the opportunity costs that your business incurs. So, let us say that I quit a job to start my own business. In order to start my own business, I am giving up the salary that I used to make at my job. This is an opportunity cost of my business. Similarly, if I set up my business in a building that I own, I am giving up the opportunity to rent that office space to someone else. This is also an opportunity cost. To get my economic profit, I have to subtract these implicit costs from my accounting profit. In many instances, businesses make zero economic profit. In fact, economists call this a “normal profit” because this is what all businesses would get if markets were completely efficient.
Thus, there is a significant difference between accounting profit and economic profit.