Economic+Profit

=Economic Profit=

Economic profit is the total amount of profit which an investor gains from an investment, taking into account __all__ the costs, including the opportunity costs. It consists of total returns minus the total costs. Following are some of the possible //returns// which an investor may recieve: the returns from land, labor, or capital; a reward for risks; or rewards for innovations. Some of the possible //costs// which an evaluation of economic profit may need to take into account include: the accounting costs (the explicit costs); the fixed costs of the capital required to produce anything at all; and the profit the investor would have recieved if she had not invested (the opportunity costs). In a perfectly competetive market, economic profit for a single firm can be best understood as the difference between marginal revenue and average total cost at equilibrium quantity. If MR is above ATC, then the firm is making an economic profit. If MR is below ATC, the firm is taking a loss. The total profit (or loss) can be found by multiplying the distance between MR and ATC by the equilibrium quantity. However, this applies only in the short run. Once the fixed costs disapear, economic profits and losses disapear as well: if firms are earning economic profit in an industry, they will enter that industry, driving prices down and reduscing profit (and if they are losing money, they will leave, because they cannot sustain such losses over the long run, thus driving prices back up and reducing losses).

Example: Say you invest $100,000 to start a business, and you pay $35,000 for employee saleries and a rent of $4,000. Instead of starting your own business you could have had a job that would pay 75,000. The money you spend came from a bank account that was earning 4.5% interest per year. Owning your own business brings you $80,000 of happiness. From that first year you earn $150,000 in revenue from your business.What are your accounting and economic profits for the first year? (Answer at bottom of page)

Total-Revenue Total-Cost Approach (Profit Maximization)

Calculating Economic Profit

[|profit (economics)] [|accounting vs economic profit] [|mises.org] [|profit and loss - by ludwig von mises]

media type="youtube" key="-a_FW2O5p6o" height="344" width="425" This video says that economic profit gives a better evaluations of profit than accounting.

Example Answer: Accounting profit 150,000 -100,000 -35,000 -4,000 =11,000

Economic profit 150,000 +80,000 -100,000 -35,000 -4,000 -6,255 (lost interest on holdings) -75,000 (opportunity costs) =9,745