3 Types of Profit
In economics, a variety of types of profits can occur. A lot of the categorization is geared around what type of costs are being considered in each situation. Profit, in general, is when your total revenue is greater than your total costs. There are a few types of profit you need to know
- Accounting profit represents your total revenue minus the firm's explicit costs. For example, if the Coca Cola company sells 3,000 2-liter bottles at $3 a piece, then they earn a total revenue of $9,000. If the total cost of producing those 2-liter bottles is $4,000, then they earn an accounting profit of $5,000.
- Economic profit represents your accounting profits minus the firm's implicit costs. Let's say that a graphic designer quits her job, which pays $60,000 annually, to open up a T-shirt making business. If the cost of producing those T-shirts was $500,000 (this would include the T-shirts, the ink, the machinery, etc.), and she made $1 million of revenue in one year, she would have an accounting profit of $500,000. However, we have to subtract the $60,000 salary she gave up to open her business to calculate economic profit. In this scenario, the economic profit would be $440,000.
- Normal profit occurs when economic profit is zero. So for example, if total revenue is $100,000 and the total of your explicit and implicit costs are $100,000, then your economic profit is zero. When we are experiencing a normal profit, it still means that our accounting profit is positive. Normal profit is also referred to as "breaking even."
Another type of profit we look at in economics is called an economic profit. Economic profit is a firm's accounting profit minus its implicit costs (opportunity costs). Let's look at a graphic designer who works for a huge firm and makes $60,000 per year. They decide to quit that job and open their own T-shirt printing business. Let's say in the first year, they sell 100,000 T-shirts at $10 apiece. That means this company earns a revenue of $1,000,000.
In some situations, if revenue is less than costs we can experience what we refer to as economic losses. For example, if the total revenue is $80 and the total cost is $97, we have an economic loss of $17.
When a firm is experiencing an economic profit, they can increase their production. If a firm is earning an economic loss, they will most likely respond by decreasing their output.
Ginny quits a job at a book publishing firm that is paying her $50,000 per year and decides to open a small book store. She decides to house the book store in a small storefront that she rented out for $15,000 a year, and spends $10,000 on bookshelves, books, and other resources. During the first year that the book store is open, Ginny generates $75,000 in total sales. What would be her accounting profit and economic profit? Did she make a normal profit that year?
Her accounting profit is $50,000 and her economic profit is $0. She made a normal profit.
Ginny's accounting profit would be $50,000 due to the $75,000 in total sales minus $25,000 in explicit costs. Her economic profit would be her accounting profit minus her implicit costs, which are the forgone wages she gave up by deciding to open a bookstore ($50,000 - $50,000 = $0). She is making a normal profit because her economic profit is $0.