Economic profit

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Definition

The economic profit of a firm or organization is defined as the difference between the total revenue of the firm and the total cost of all its factors of production, including their opportunity costs.

Economic profit differs from accounting profit in two ways:

  • Economic profit measures the cost of a factor of production in terms of its opportunity cost, rather than in terms of the nominal amount paid for the factor of production. For instance, the cost of a worker is measured not by the wage the worker is being paid, but rather, by the minimum wage that would have been necessary to attract the worker to the firm (since that minimum would reflect the opportunity cost). Note that the extra amount that the worker is paid over and above the minimum is thus a part of the economic profit shared by the worker.
  • Economic profit also places an economic value on the work of entrepreneurs/business owners who may not be drawing a wage or salary.