Profit (economics)

An economic profit is the difference between the revenue a commercial entity has received from its outputs and the opportunity costs of its inputs.[1][2][need quotation to verify] Unlike an accounting profit, an economic profit takes into account both a firm's implicit and explicit costs, whereas an accounting profit only relates to the explicit costs which appear on a firm's financial statements. Because it includes additional implicit costs, the economic profit usually differs from the accounting profit.[3]

Economists often view economic profits in conjunction with normal profits, as both consider a firm's implicit costs. A normal profit is the profit that is necessary to cover both the implicit and explicit costs of a firm and of the owner-manager or investors who fund it. In the absence of this profit, these parties would withdraw their time and funds from the firm and use them to better advantage elsewhere, as to not forgo a better opportunity. In contrast, an economic profit, sometimes called[by whom?] an excess profit, is the profit remaining after both the implicit and explicit costs are covered.[3]

The enterprise component of normal profit is the profit that business owners consider necessary to make running the business worth their time, i.e., it is comparable to the next-best amount the entrepreneur could earn doing another job.[4] In particular, if enterprise is not included as a factor of production, it can also be viewed as a return to capital for investors including the entrepreneur, equivalent to the return the capital owner could have expected (in a safe investment), plus compensation for risk.[5] Normal profit varies both within and across industries; it is commensurate with the riskiness associated with each type of investment, per the risk-return spectrum.

Economic profits arise in markets which are non-competitive and have significant barriers to entry, i.e. monopolies and oligopolies. The inefficiencies and lack of competition in these markets foster an environment where firms can set prices or quantities instead of being price-takers, which is what occurs in a perfectly competitive market.[6][need quotation to verify] In a perfectly competitive market when long-run economic equilibrium is reached, an economic profit becomes non-existent - because there is no incentive for firms either to enter or to leave the industry.[7]