In economics,
economic profit is the difference between a company's total
revenue and its
opportunity costs. It is the increase in
wealth that an
investor has from making an investment, taking into consideration all costs associated with that investment including the
opportunity cost of
capital.
An economic profit arises when revenue exceeds the opportunity cost of inputs, noting that these costs include the cost of equity capital that is met by "normal profits." A business is said to be making an accounting profit if its revenues exceed the accounting cost of the firm.[1]
All enterprises can be stated in financial capital of the owners of the enterprise. The economic profit may include an element in recognition of the risks that an investor takes. It is often uncertain, because of incomplete information, whether an enterprise will succeed or not. This extra risk is included in the minimum rate of return that providers of financial capital require, and so is treated as still a cost within economics. The size of that return is commensurate with the riskiness associated with each type of investment, as per the risk-return spectrum.
"Normal profits" arise in circumstances of perfect competition when economic equilibrium is reached. At equilibrium, average cost equals marginal cost at the profit-maximizing position. Since normal profit is economically a cost, there is no economic profit at equilibrium. In a single-goods case, a positive economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity of output multiplied by the difference between the average cost and the price.
