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Types of
Profit

Understand the critical difference between accounting profit, economic profit, and normal profit: the concepts that drive every firm's decision to enter, stay, or exit a market.

AP Microeconomics

What Is Profit?

At its simplest, profit is the difference between what a firm earns and what it spends. But what counts as a cost changes everything. Economists and accountants measure profit differently because they include different costs.

Revenue and Cost Building Blocks

Total Revenue (TR)
The total income a firm receives: \( TR = P \times Q \)
Explicit Costs
Direct, out-of-pocket payments: wages, rent, materials, utilities
Implicit Costs
Opportunity costs of resources the owner already owns: forgone salary, forgone interest

Explicit vs. Implicit Costs

TOTAL ECONOMIC COSTS Explicit Costs Wages & Salaries Rent & Lease Payments Raw Materials Utilities & Insurance Recorded on books ✓ Implicit Costs Forgone Salary Forgone Interest Forgone Rent on Property Owner's Time NOT on books ✕

Accounting Profit

Accounting profit is what appears on a firm's income statement. It subtracts only explicit costs from total revenue. It ignores opportunity costs entirely.

A firm with positive accounting profit may still be making a poor decision economically: the owner's resources could be earning more elsewhere.

Economic Profit

Economic profit subtracts all costs: both explicit and implicit. It is the true measure of whether a firm is using its resources in the most valuable way.

Normal Profit

Normal profit occurs when economic profit equals exactly zero. The firm covers all explicit and implicit costs: the owner earns exactly as much as the next-best alternative would pay.

Normal profit is not zero profit in the accounting sense: the firm still has positive accounting profit. "Normal" simply means the firm is breaking even on all costs including opportunity costs.

The Core Relationship

Total Revenue Accountant's View Explicit Costs Accounting Profit Economist's View Explicit Costs Implicit Costs Econ. Profit

Accounting vs. Economic Profit

Accounting Profit Economic Profit
Costs Subtracted Explicit only Explicit + Implicit
Includes Opportunity Cost? No Yes
Used By Accountants, IRS Economists, firms deciding entry/exit
Can Be Negative? Yes (a loss) Yes (economic loss)
Magnitude Always \( \ge \) Economic Profit Always \( \le \) Accounting Profit

Why It Matters: Entry and Exit

\( \text{Economic Profit} > 0 \)
Firms earn more than their next-best alternative. New firms enter the market, increasing supply.
\( \text{Economic Profit} = 0 \)
Firms earn exactly their opportunity cost (normal profit). No incentive to enter or exit.
\( \text{Economic Profit} < 0 \)
Firms earn less than opportunity cost. Firms exit the market, decreasing supply.

How to Calculate Profit

1
Find Total Revenue. Multiply price by quantity: \( TR = P \times Q \).
2
List all explicit costs. Wages, rent, materials, utilities: every out-of-pocket payment.
3
Compute accounting profit. \( \text{Accounting Profit} = TR - \text{Explicit Costs} \).
4
List all implicit costs. Forgone salary, forgone interest, forgone rent: what the owner sacrifices.
5
Compute economic profit. \( \text{Economic Profit} = \text{Accounting Profit} - \text{Implicit Costs} \).

Example 1: Sara's Bakery

Sara quits her $50,000/year job to open a bakery. She invests $100,000 of savings that was earning 5% interest. In Year 1, she earns $200,000 in revenue and pays $120,000 in explicit costs.

1
Total Revenue: $200,000
2
Explicit Costs: $120,000
3
Accounting Profit: \( \$200{,}000 - \$120{,}000 = \) $80,000
4
Implicit Costs: Forgone salary $50,000 + Forgone interest \( 0.05 \times \$100{,}000 = \) $5,000 = $55,000
5
Economic Profit: \( \$80{,}000 - \$55{,}000 = \) $25,000

Example 1: Interpretation

TR $200k Explicit $120k Acct. Profit $80k Explicit $120k Implicit $55k Econ. $25k

Example 2: Marcus's Tutoring Firm

Marcus leaves a $70,000/year job and uses $20,000 savings (earning 4%) to start a tutoring business. Revenue: $110,000. Explicit costs: $30,000.

1
Accounting Profit: \( \$110{,}000 - \$30{,}000 = \) $80,000
2
Implicit Costs: \( \$70{,}000 + (0.04 \times \$20{,}000) = \$70{,}000 + \$800 = \) $70,800
3
Economic Profit: \( \$80{,}000 - \$70{,}800 = \) $9,200

Example 3: Normal Profit in Action

Priya could earn $60,000 at a corporate job. She starts a consulting firm. Revenue: $150,000. Explicit costs: $90,000. No invested savings.

1
Accounting Profit: \( \$150{,}000 - \$90{,}000 = \) $60,000
2
Implicit Costs: Forgone salary = $60,000
3
Economic Profit: \( \$60{,}000 - \$60{,}000 = \) $0

Common Mistakes

✕ "Zero profit means no money"
Zero economic profit means the firm covers all costs including opportunity costs. The owner still takes home accounting profit.
✕ Forgetting implicit costs
Students often subtract only explicit costs and report that number as "profit." On the AP exam, check whether the question asks for accounting or economic profit.
✕ Confusing normal and zero
Normal profit = zero economic profit, not zero accounting profit. The firm is still profitable by accounting standards.

Question 1 of 5

A firm has total revenue of $300,000, explicit costs of $200,000, and implicit costs of $60,000. What is the firm's economic profit?

Question 2 of 5

When a firm earns normal profit, which of the following is true?

Question 3 of 5

An entrepreneur gives up a $45,000 salary and $5,000 in interest on invested savings to start a business. The business earns $120,000 in revenue with $65,000 in explicit costs. What is the accounting profit?

Question 4 of 5

In a perfectly competitive market, if firms are currently earning positive economic profit, what will happen in the long run?

Question 5 of 5

A firm has accounting profit of $80,000 and implicit costs of $95,000. The firm is experiencing: