Profit comes in different forms depending on which costs you subtract. Accounting profit is total revenue minus explicit costs only, while economic profit is total revenue minus both explicit and implicit costs.
Why This Matters for the AP Microeconomics Exam
Profit types connect cost-benefit thinking to real firm decisions. Once you can separate explicit costs from implicit costs, you can explain why a firm that looks profitable on paper might actually be earning zero or negative economic profit. This idea drives a lot of the analysis later in Unit 3, including profit maximization and the choice to enter or exit a market. Expect to define and calculate the different profit types from given data, and to explain how firms respond to profit or loss signals.
Key Takeaways
- Profit in general means total revenue is greater than total cost: Profit = TR - TC.
- Accounting profit = TR - explicit costs (the out-of-pocket payments a firm actually makes).
- Economic profit = TR - (explicit costs + implicit costs), where implicit costs are the value of giving up the next best use of your own resources.
- Normal profit happens when economic profit is zero, which still means accounting profit is positive. This is the break-even point.
- Firms respond to economic profit and loss, not accounting profit. Economic profit signals firms to expand; economic loss signals them to cut back or exit.
- Implicit costs include things like a forgone salary, the cost of using your own financial capital, an entrepreneur's time, and compensation for risk.
The Three Types of Profit
Profit depends on which costs you count. The starting formula is always the same:
Profit = Total Revenue - Total Cost
What changes is which costs go into "total cost." That is the whole reason these profit types exist.
Accounting Profit
Accounting profit is total revenue minus explicit costs. Explicit costs are the actual money payments a firm makes, like wages, rent, materials, and machinery.
Accounting profit = TR - explicit costs
Example: If a company sells 3,000 bottles at $3 each, total revenue is $9,000. If explicit costs to produce them are $4,000, accounting profit is $5,000.
Economic Profit
Economic profit subtracts both explicit costs and implicit costs. Implicit costs are the opportunity costs of using resources you already own instead of selling or renting them out. Things like a forgone salary, the cost of your own financial capital, and the value of an entrepreneur's time all count here.
Economic profit = TR - (explicit costs + implicit costs)
Example: A graphic designer quits a $60,000-per-year job to open a T-shirt business. Her explicit costs (shirts, ink, machinery) are $500,000, and she earns $1 million in revenue. Her accounting profit is $500,000. But she gave up a $60,000 salary, which is an implicit cost. Her economic profit is $500,000 - $60,000 = $440,000.
Because economic profit always subtracts more costs, economic profit is always less than or equal to accounting profit.
Normal Profit
Normal profit occurs when economic profit is exactly zero. This still means accounting profit is positive, because all implicit costs are being fully covered but there is nothing extra left over. Normal profit is the break-even point.
If total revenue is $100,000 and explicit plus implicit costs total $100,000, economic profit is zero. The firm is earning normal profit.
Economic Loss
When total revenue is less than total cost, the firm has an economic loss, which is just a negative economic profit. If total revenue is $80 and total cost is $97, the economic loss is $17 (TR < TC).
How Firms Respond to Profit and Loss
Firms make decisions based on economic profit, not accounting profit. That distinction matters because a firm can show a positive accounting profit while still earning zero or negative economic profit once implicit costs are counted.
- Positive economic profit signals that resources are more valuable here than in their next best use, so firms have an incentive to expand or enter the market.
- Economic loss signals that resources would be more valuable elsewhere, so firms have an incentive to cut back or exit.
- Normal profit (zero economic profit) means there is no incentive to enter or leave, since the firm is doing exactly as well as its next best option.
This profit signal is what reallocates resources across markets. You will see this logic again when studying entry, exit, and long-run equilibrium later in Unit 3.
How to Use This on the AP Microeconomics Exam
Problem Solving
When a question gives you revenue and cost data, work in this order:
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Find total revenue: TR = Price x Quantity.
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Identify explicit costs (actual payments).
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Compute accounting profit: TR - explicit costs.
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Identify implicit costs (forgone salary, value of owner's capital or time).
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Compute economic profit: accounting profit - implicit costs.
Worked example: You sell games at $30 each and sell 100,000 of them, so TR = 30 x 100,000 = $3,000,000. Fixed costs are $1,000,000 and variable cost is $2 per game, so explicit total cost = 1,000,000 + (2 x 100,000) = $1,200,000. Accounting profit = 3,000,000 - 1,200,000 = $1,800,000. Now add a forgone salary of $40,000,000 as an implicit cost. Economic profit = 3,000,000 - (1,200,000 + 40,000,000) = -$38,200,000. The business looks profitable on paper but produces a large economic loss once opportunity cost is included.
Free Response
- Define each profit type precisely. Graders want the cost categories named, not just a formula.
- When asked how a firm responds, tie your answer to economic profit. Say that positive economic profit encourages expansion or entry and that economic loss encourages contraction or exit.
- If a prompt says a firm earns "zero economic profit," recognize that this is normal profit and the firm is still covering all costs, including implicit ones.
Common Trap
Watch for any resource the owner already controls, such as a building they own outright or their own time. Even if no cash changes hands, the forgone value is an implicit cost and must be subtracted to find economic profit.
Sample Questions
Question 1:
Ginny quits a job at a book publishing firm that pays her $50,000 per year and decides to open a small book store. She houses the store in a storefront she rents for $15,000 a year and spends $10,000 on bookshelves, books, and other resources. During the first year, Ginny generates $75,000 in total sales. What is her accounting profit and economic profit? Did she make a normal profit that year?
Answer: Her accounting profit is $50,000 and her economic profit is $0. She made a normal profit.
Explanation: Accounting profit is $75,000 in sales minus $25,000 in explicit costs (the $15,000 rent plus $10,000 in resources), which equals $50,000. Economic profit subtracts her implicit cost, the $50,000 salary she gave up: $50,000 - $50,000 = $0. Because economic profit is zero, she is earning normal profit.
Question 2:
You sell video games for $30 each and sell 100,000 over a year. Your fixed costs are $1,000,000 and your variable cost is $2 per game. You gave up a job paying $40,000,000 per year to open the shop. Assume you take home all the revenue and pay all the costs. What is your (a) accounting profit and (b) economic profit?
Answer and Explanation:
Part (a):
TR = P x Q = 30 x 100,000 = $3,000,000
TC (explicit) = FC + VC = 1,000,000 + (2 x 100,000) = $1,200,000
Accounting profit = TR - TC = 3,000,000 - 1,200,000 = $1,800,000.
This is accounting profit because it ignores the opportunity cost of the job you gave up.
Part (b):
Add the forgone salary as an implicit cost: Economic cost = 1,200,000 + 40,000,000 = $41,200,000.
Economic profit = 3,000,000 - 41,200,000 = -$38,200,000.
Once you include the opportunity cost, opening the shop produces a large economic loss even though it is profitable on paper.
Common Misconceptions
- Accounting profit and economic profit are not the same thing. Economic profit always counts implicit costs too, so it is lower than accounting profit whenever any implicit costs exist.
- Normal profit is not zero profit in every sense. Economic profit is zero, but accounting profit is still positive because implicit costs are being fully covered.
- Implicit costs are real costs even when no money is spent. A forgone salary or the use of your own capital reduces economic profit.
- Firms respond to economic profit, not accounting profit. A firm with positive accounting profit may still choose to exit if its economic profit is negative.
- Earning zero economic profit does not mean a firm is failing. It means the firm is doing exactly as well as its next best alternative.
Related AP Microeconomics Guides
Vocabulary
The following words are mentioned explicitly in the College Board Course and Exam Description for this topic.Term | Definition |
|---|---|
accounting profit | The difference between total revenue and explicit costs only, without accounting for implicit costs or opportunity costs. |
economic profit | The difference between total revenue and total economic cost, including both explicit and implicit costs. |
implicit costs | Opportunity costs of using resources owned by the firm that do not involve direct monetary payments, such as the cost of financial capital, compensation for risk, or an entrepreneur's time. |
marginal benefits | The additional benefit or satisfaction gained from consuming or producing one more unit of a good. |
marginal costs | The additional cost incurred from producing one more unit of output. |
normal profit | The level of profit earned when all implicit costs are fully compensated, resulting in zero economic profit. |
profit | The difference between total revenue and total cost, representing the financial gain or loss from economic activity. |
Frequently Asked Questions
What are the main types of profit in AP Microeconomics?
AP Microeconomics uses accounting profit, economic profit, normal profit, and economic loss. Accounting profit subtracts explicit costs only, economic profit subtracts explicit and implicit costs, normal profit means economic profit is zero, and economic loss means economic profit is negative.
What is the difference between accounting profit and economic profit?
Accounting profit equals total revenue minus explicit costs, such as wages, rent, and materials. Economic profit equals total revenue minus explicit costs and implicit costs, so it includes opportunity costs like a forgone salary or the owner's time.
What are implicit costs?
Implicit costs are opportunity costs of using resources the owner already controls. Examples include a salary the owner gave up, income that could have been earned by renting out a building, or the value of the owner's time and capital.
What is normal profit?
Normal profit occurs when economic profit is zero. The firm is covering all explicit and implicit costs, so it is doing as well as its next best alternative even though accounting profit can still be positive.
Why do firms respond to economic profit instead of accounting profit?
Firms respond to economic profit because it includes opportunity cost. Positive economic profit signals that resources are better used in the firm, while economic loss signals that resources may be more valuable in another use.
How do I calculate profit and loss on the AP Micro exam?
Start with total revenue, usually price times quantity. Then compute accounting profit as total revenue minus explicit costs, and economic profit as total revenue minus explicit and implicit costs. A positive result is economic profit, zero is normal profit, and a negative result is economic loss.