Could anyone explain me the difference between economic profit and normal profit being talked off in the Econ book? It’s getting way too confusing to further-read the book, until I nail this concept. - Dinesh S
Do you know what an opportunity cost is?
yes, the concept of ‘opportunity cost’ is firm on me. Then?? - Dinesh S
As far as I know the only difference is that economic profit takes opportunity cost (implicit cost) into consideration, where accounting profit does not. So if you had a high opportunity cost, you could make an accounting profit, but have little to no economic profit.
This is what all I could concur… is my understanding correct?? Normal Profit - this is the real profit you get… For example, you have a land worth 100K and then you decide to start a business on it. For ex: you build a Starbucks there... So let's say you invested 20K in starting the Starbucks and at the year end, you are in profit and your earnings out of that business are 50K$ … so your NET PROFIT is 50K$ - 20K$ = 30K$ But the land you used to build up your business could have been rented to someone for an annual charge of 10K$ … but you lost this opportunity to earn this 10K$ and instead you started your own business… So economic loss will take into account of this lost opportunity (also called the opportunity cost)… so economic profit will be, 50K$ earned - 20K$ initial outlay - 10K$ opportunity cost = 20K$ I know in US, we don’t build a Starbucks; we need to purchase a license for a ‘Starbucks franchise’, nevertheless, not that bad an example? - Dinesh S
I’m trying to teach you how to fish… not feed you go onto investopedia.com and search for economic profit. pay special attention to the opportunity cost part. if that doesnt answer your question then let me know. Edit: I didn’t see the above posts when i wrote this…
Eco profit is revenues earned minus the opportunity costs of the inputs used in the production of the good. For example, your revenues for the year are $1,000 and your costs are $600. Your accounting profit is $400. If you want to come up with the eco profit, you’ll have to know the opportunity cost of the factors of production. Let’s say the opportunity costs are $500 (this could be for example wages you could have earned elsewhere, that you have foregone as a result of spending time on this project). In that case you have a negative eco profit: $1000 - $600 - $500, even though your accounting profit is still $400. does that help?
Dinesh, I saw your example after I had posted mine. You’re on the right track.
I would much rather be fed.
Perfect!! Thanks lola, that confirms my understand. Will try reading further and revert back to the wonderful AF group for any further queries… - Dinesh S
Except it’s not right. Normal profits is some messed-up name for opportunity costs. Normal profits don’t represent profits at all but represent costs (remember economists were all not stabe enough to become accountants). Accounting profits = Revenues - Explicit Costs In your example, what you call NET PROFIT is accounting profit (30K). In your example economic profit is 20K (only if you value your time at 0, incidentally). Normal Profits = accounting profits - economic profits which a little tiny bit of math says is just implicit costs. It’s messed up terminology.
I thought normal profit is accounting profit. Sorry for the confusion.
The CFAI book states: ‘The return that an entrepreneur can expect to receive on average is called normal profit. Normal profit is part of a firm’s opportunity cost’ So the ‘average’ profit of being in a certain business is part of the opportunity cost and must be deducted to calculate your economic profit. In the CFAI example it states that if normal profit for the textile industry is 50,000 USD then that amount needs to be deducted as an opportunity cost for a textile producer. This also the reason why in pefect competition there are no economic profits but the producers still receive a normal profit. Hope that helps
ZXL Wrote: ------------------------------------------------------- > The CFAI book states: ‘The return that an > entrepreneur can expect to receive on average is > called normal profit. In fact, the minimum return required by an entrepeneur to make an investment palatable is the normal profit. The sentence might also be true if you used perfect competition. Most entrepeneurs I know want some economic profit, too. As written, the sentence is just not true. > Normal profit is part of a > firm’s opportunity cost’ > > So the ‘average’ profit of being in a certain > business is part of the opportunity cost and must > be deducted to calculate your economic profit. In > the CFAI example it states that if normal profit > for the textile industry is 50,000 USD then that > amount needs to be deducted as an opportunity cost > for a textile producer. > That’s true. > > This also the reason why in pefect competition > there are no economic profits but the producers > still receive a normal profit. Hope that helps In perfect competition by definition everyone receives a normal profit. That just means that revenues = costs where costs include opportunity costs as well as explicit costs.