Profit (economics)

In the field of economics, profit is defined as the surplus value left over after a firm accounts for its costs. It is the difference between the total revenue a business receives and the total cost of its inputs. While people often use the word profit generally, economists distinguish it from accounting profit. An accountant calculates profit by subtracting only explicit costs from total revenue. Explicit costs are the direct, visible payments found on financial statements.

An economist uses a much broader definition to analyze a firm. They subtract both explicit costs and implicit costs from total revenue. Implicit costs are not direct payments but represent the value of resources used. Because economists include these extra costs, economic profit is almost always smaller than accounting profit. This detailed view helps researchers understand the true cost of doing business. It provides a more complete picture of how resources are being used in an economy.

There is also a concept known as normal profit. This occurs when a company's total revenue is exactly equal to its total costs. In this specific state, the economic profit is equal to zero. Normal profit is considered the minimum level of income a company needs to stay operational. It signifies that resources are being used in the most efficient and highest way possible. In a competitive industry, reaching normal profit allows a company to continue its work without losing money.

Market structures determine how much economic profit a firm can actually keep. In a perfectly competitive market, economic profits are usually temporary. If a firm makes a high economic profit, it creates an incentive for new competitors to enter. These new firms increase the total supply of the product. To attract customers, they must offer lower prices.

As competition increases, prices fall until they reach the level of average total costs. Eventually, the market reaches a long-run equilibrium where economic profit disappears.

Some markets are uncompetitive, which allows for much higher profits. A monopoly exists when only one firm supplies a good with no close substitutes. An oligopoly is a market dominated by just a few large firms. These companies often possess market power, meaning they can act as price setters rather than price takers. They can set prices or quantities to maintain high economic profits.

This is much more common in markets where there are significant barriers to entry.

Barriers to entry are obstacles that prevent new firms from joining a market. Common examples include patents, land rights, and specific zoning laws. These barriers protect the market share of existing firms. In an oligopoly, firms might even collude to limit production and restrict supply. This keeps prices high and ensures a constant economic profit. Without these barriers, new competitors would quickly enter and drive the economic profit down to zero.

Because uncompetitive markets can lead to higher prices, governments often intervene. They use competition laws to prevent powerful firms from creating artificial barriers. For instance, the United States government took action against Microsoft Corporation for anti-competitive behavior. This oversight helps ensure that new firms can enter the market to compete. In other cases, like a natural monopoly, the government may allow one firm to exist but will regulate it.

Regulators examine costs to ensure the firm does not charge unfair prices. This balance helps protect consumers while allowing the industry to function.