Accounting Profit vs Economic Profit
Accounting Profit and Economic Profit are two Production & Costs concepts in AP Economics that students often mix up. Accounting profit is total revenue minus explicit costs, as recorded on a firm's financial statements. Economic profit is total revenue minus both explicit and implicit costs, including opportunity costs. Here is how they compare side by side.
Explicit costs are direct, out-of-pocket payments like wages, rent, and materials. Accounting profit does not include opportunity costs, so it is typically higher than economic profit. It is used for tax and reporting purposes.
Implicit costs represent the value of resources the firm owns, such as the owner's time or capital. Economic profit accounts for all costs of production, making it a better measure of true profitability. A firm earns zero economic profit when it covers all opportunity costs.
Accounting Profit vs Economic Profit: Which Costs Get Subtracted
| Accounting profit | Economic profit | |
|---|---|---|
| Formula | Total revenue minus explicit costs | Total revenue minus explicit costs minus implicit costs |
| Costs included | Out-of-pocket payments only | Out-of-pocket payments plus the value of forgone alternatives |
| Which is larger | Always the larger of the two, or equal if implicit costs are zero | Always the smaller |
| Who uses it | Accountants, tax authorities, investors reading a filing | Economists deciding whether resources are in their best use |
| Zero means | The firm broke even in cash terms | The firm is earning exactly what its resources would earn elsewhere |
| Signal it sends | None about entry or exit | Positive draws entry, negative drives exit, zero means long-run equilibrium |
The gap between them is always the implicit costs
Explicit costs are payments a firm actually makes: wages, rent, materials, interest. Implicit costs are the value of resources the owner already has and uses in the business, which therefore earn nothing elsewhere. The salary you gave up to run your own shop is an implicit cost. So is the interest your own capital would have earned, and the rent you could have collected on a building you own and occupy. Accounting profit subtracts only the first list. Economic profit subtracts both. That is the entire distinction, and exam questions test it by handing you a scenario with one obvious forgone salary buried in the middle of a list of ordinary expenses. See /glossary/compare/explicit-costs-vs-implicit-costs for the cost side in detail, and check your arithmetic at /calculate/economic-profit.
A worked example, because the numbers make it obvious
Suppose you quit a job paying 60,000 dollars a year to open a bakery. Revenue is 200,000 dollars. You pay 90,000 in ingredients, wages, and utilities, and 30,000 in rent. Accounting profit is 200,000 minus 120,000, which is 80,000 dollars, and that is the number on your tax return. Economic profit subtracts the 60,000 salary you gave up as well, leaving 20,000 dollars. The bakery is still worth running, because 20,000 dollars of economic profit means you are 20,000 dollars better off than in your best alternative. Now suppose revenue had been 170,000 instead. Accounting profit is 50,000, which looks fine, but economic profit is negative 10,000, and the correct economic conclusion is that you should go back to the job.
Why zero economic profit is not failure
Zero economic profit, sometimes called normal profit, means the firm is earning exactly what its resources would earn in their next best use. Nobody has any reason to enter the industry and nobody has any reason to leave, which is precisely the definition of long-run equilibrium in perfect competition. A firm at zero economic profit is still earning a positive accounting profit equal to its implicit costs, so the owner is doing perfectly well. Students routinely lose points by writing that firms in long-run competitive equilibrium make no profit at all. They make no ECONOMIC profit. Say which kind you mean every single time, and see the long-run adjustment on the diagram at /sandbox/perfect-competition.
Frequently asked questions
What is the difference between accounting profit and economic profit?
Accounting profit is total revenue minus explicit costs, the payments a firm actually makes. Economic profit also subtracts implicit costs, the value of the owner's own resources in their next best use. Economic profit is therefore always less than or equal to accounting profit, and the gap between them is exactly the implicit costs.
Can a firm have positive accounting profit and negative economic profit?
Yes, and it is common. A business can generate more cash than it spends while still earning less than the owner's resources would earn elsewhere. Yes, and it is common. A business can generate more cash than it spends while still earning less than the owner's resources would earn elsewhere. In the long run that signals exit: the owner would do better in the next best alternative, so the resources should leave the industry. It does not mean stop producing today. In the short run the firm keeps operating whenever total revenue still covers total variable cost, that is whenever price is at least average variable cost, because costs already committed are paid whether it produces or not. Put the forgone salary on the variable side of that comparison, since walking away recovers it.
What does zero economic profit mean?
It means the firm is earning exactly its opportunity cost, so resources have no reason to move in or out of the industry. It is the long-run outcome under perfect competition and under monopolistic competition. The firm still earns a positive accounting profit equal to its implicit costs, so the owner is not losing money.
Want the long version? Economic Profit vs Accounting Profit (With a Worked Example) walks through the same comparison as a full guide, with worked examples and the exam traps. This page is the quick side-by-side.
Live Perfect Competition graph. Drag the curves, or open the full version.
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