Cost, Profit, and Revenue Run-Down
Updated 8/15/2017 Jacob Reed
Here is a run-down of the difference between accounting profit and economic profit. Also learn about revenue and all the costs for a firm. It is important to understand these graphs come from real numbers. They are not just shapes on a graph. Make sure you know what the curves look like and know how to calculate them.
After you read through this, practice your calculations with the 20 question Cost, Profit, and Revenue Review game.
In microeconomics there are actually two types of profit you need to know: accounting profit and economic profit.
Accounting Profit: This is what most people think of as profit and although it isn’t nearly as important as economic profit, it shows up on many economics exams.
Accounting profit is total revenue minus explicit costs. Total revenue is the money brought in through sales (P x Q = TR). Explicit costs are the out of pocket costs paid by the business owner. Explicit costs for this website are the hosting fees, and the cost of the software. For this website, accounting profit would be the revenue generated for the ads minus the web hosting fees and the cost of the software.
Note: Accounting profit is always higher than economic profit.
Economic Profit: It is much more important to economists than accounting profit. Economic profit is Total Revenue minus Explicit and Implicit costs. Implicit costs are the implied costs; or the value of opportunities lost (aside from out of pocket money costs). So for this website, economic profit would subtract not only the hosting and software costs but also the cost of my time (labor) for creating the content.
On every one of the firm graphs, both implicit and explicit costs are contained within the cost curves. So if a firm is making a profit, it is an economic profit. If they are suffering a loss, it is an economic loss. If they are making zero economic profit (breaking even), they are still making an accounting profit.
Breaking Even or Zero Economic Profit
When a firm is earning zero economic profit, its total revenue equals its total costs (both implicit and explicit). On the firm graphs, price will equal ATC. When that occurs, the entrepreneur will be earning whatever they could be earning doing the next best alternative. A teacher who quits teaching to become a street performer would break even (earn zero economic profit) if they earn a teacher’s salary by street performing. This person would still be earning an accounting profit. They would have to earn more than a teacher’s salary to be earning an economic profit.
Revenue is money a firm brings in for sales. Total Revenue is Price time Quantity (TR = P x Q). Marginal revenue is the change in Total Revenue divided by the change in Quantity (MR = ∆TR/∆Q). Often the change in quantity is just one, so marginal revenue is the new revenue a firm brings in for producing one more unit of output.