In economic analysis, the term ‘profit’ is perhaps the easiest to define, but the least understood.
An economic profit or loss is the difference between the revenue received from the sale of an output and the opportunity cost of the inputs used. In calculating economic profit, opportunity costs are deducted from revenues earned.
Economic profit is the difference between total monetary revenue and total costs, but total costs include both explicit financial and implicit opportunity costs. An accounting profit only considers financial costs associated with production and is therefore higher than economic profit.
Economic profit accrues to producers as a return for marshaling and using the resources of the economy to create goods and services.
However it does not occur in perfect competition in the long run equilibrium; if it did, there would be an incentive for new firms to enter the industry, aided by a lack of barriers to entry until there was no longer any economic profit.
This Micro Brief is part of an ongoing series provided as a general public information service. These concepts underpin modern economic analysis. Find out more about smarter capital investment decisions using economics at www.lyttonadvisory.com.au.