Encyclonomic WEB*pedia: PROFIT

PROFIT:
Generally speaking, the difference between revenue received by a firm for production and cost incurred in the production, or the excess of revenue over cost. Three specific notions of profit exist, each with a different meaning. Accounting profit is the difference between revenue and accounting cost. Economic profit is the difference between revenue and total opportunity cost. Normal profit is opportunity cost of entrepreneurship. Profit is occasionally used synonymously with the term rent, or economic rent.
In general, profit is the revenue remaining after paying expenses. It is the primary motivator for a great deal of production activity undertaken by business firms. The common catch-phrase is that firms seek to "maximize profit." This pursuit of profit creates important incentives to achieve an efficient allocation of resources.
Greater profit can be achieved by increasing revenue or by decreasing cost.
Revenue can be increased by producing products with higher prices. But prices are higher because buyers are willing to pay more, which presumes they receive greater satisfaction (or utility).

Cost can be decreased by using resources with lower prices, meaning resources with lower opportunity cost. But opportunity cost is lower because alternative goods and services produced by the resources are less valuable.
All together, the pursuit of profit motivates firms to allocate resources to the production of goods and services that are most highly valued by society. Firms allocate resources away from goods that are less valuable and which generate less profit. These resources are then allocated toward goods that are more value, and which generate more profit.
Revenue Minus Cost
A generic formula for specifying and calculating profit is:
profit = revenue - cost
The critical consideration in this formula is what exactly is included as "cost." Accounting profit includes accounting expenses as "cost." Economic profit includes economic, or opportunity, cost as "cost."
Profit Times Three
Different types of cost underlie three common notions of profit in the study of economics, especially short-run production of a firm--accounting profit, economic profit, normal profit.
Accounting Profit: The most common notion of profit in the real world of business activity, is the difference between revenue and accounting cost. This is the profit listed on a firm's balance sheet, appears periodically in the financial sector of the newspaper, and is reported to the Internal Revenue Service for tax purposes. When real world talk turns to profit, it is invariably accounting profit.
Accounting profit is based on accounting cost--the explicit, out-of-pocket, expenses incurred by a firm. While these explicit payments often compensate resources for their opportunity cost, such is not necessarily the case. In some cases, an accounting cost is made even though no opportunity cost has occurred. In other cases, an opportunity cost is incurred without an explicit payment.

Economic Profit: The notion of profit preferred in economics is the difference between the total revenue received by a firm and the total opportunity cost of production. Economic profit is what remains after ALL opportunity cost associated with production, the opportunity cost incurred by ALL factors of production, is deducted from the revenue generated by the production.
Economic profit is the "conceptually correct" notion of profit used in economics. If profit is revenue minus cost, then economic profit is THE measure of profit.

Normal Profit: The last notion of profit is the opportunity cost of using entrepreneurial abilities in the production of a good, or the profit that could have been received by entrepreneurship in another business venture. Like the opportunity costs of other resources, normal profit is deducted from revenue when determining economic profit. It is, however, never included as an accounting cost when accounting profit is computed.
Economic Profit and Rent
Economic profit is closely related to the term economic rent. In many cases the two terms can be use synonymously with no loss of meaning. Both are the excess of revenue received over opportunity cost. If a difference does exist, it is based on who receives the economic profit/rent. Economic profit is generally the term used when a firm has an excess of revenue over opportunity cost. Economic rent, in contrast, is commonly used when a specific resource receives revenue (that is, factor payment) over and above opportunity cost.
The idea of economic rent as an excess payment has its basis in rental payments to landowners. The presumption is that because the land is "fixed" in supply, then the land would be supplied regardless of rental payment. Whether the rent is high or low, the quantity of land supplied is the same. While this idea is not really correct--land has alternative uses just like any other resource--the idea that economic rent represents excess revenue, like economic profit, remains in use.
Check Out These Related Terms...
     | economic profit | accounting profit | normal profit | accounting cost | profit maximization |
Or For A Little Background...
     | opportunity cost | explicit cost | economic cost | cost | production | production cost | business | factors of production | microeconomics | short-run production analysis |
And For Further Study...
     | total cost | variable cost | fixed cost | average cost | marginal cost | legal business organizations | firm objectives | opportunity cost, production possibilities |
Recommended Citation:
     PROFIT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2025. [Accessed: April 7, 2025].