3.4 Types of Profit

Accounting profit = total revenue − explicit costs (actual payments for inputs). Economic profit = total revenue − explicit costs − implicit costs, where implicit costs are the opportunity costs of resources the owner already controls, like forgone salary and forgone interest on invested funds. Economic profit is therefore always less than or equal to accounting profit.

Zero economic profit is called normal profit, and it is not failure: the firm earns exactly what its resources would in their next-best use, so the owner has no reason to leave. A firm can show a healthy accounting profit while making zero, or negative, economic profit.

Economists use economic profit because it drives behavior: positive economic profit attracts entry into an industry, negative economic profit drives exit. That entry-and-exit logic is exactly what pushes perfectly competitive firms to zero economic profit in the long run (topic 3.7).