Greater profit can be achieved by increasing revenue or by decreasing cost.

• Revenue can be increased by producing products with higher prices. But prices are higher because buyers are willing to pay more, which presumes they receive greater satisfaction (or utility).


• Cost can be decreased by using resources with lower prices, meaning resources with lower opportunity cost. But opportunity cost is lower because alternative goods and services produced by the resources are less valuable.

Revenue Minus Cost

profit

=

revenue - cost

Profit Times Three

• Accounting Profit: The most common notion of profit in the real world of business activity, is the difference between revenue and accounting cost. This is the profit listed on a firm's balance sheet, appears periodically in the financial sector of the newspaper, and is reported to the Internal Revenue Service for tax purposes. When real world talk turns to profit, it is invariably accounting profit.

  Accounting profit is based on accounting cost--the explicit, out-of-pocket, expenses incurred by a firm. While these explicit payments often compensate resources for their opportunity cost, such is not necessarily the case. In some cases, an accounting cost is made even though no opportunity cost has occurred. In other cases, an opportunity cost is incurred without an explicit payment.



• Economic Profit: The notion of profit preferred in economics is the difference between the total revenue received by a firm and the total opportunity cost of production. Economic profit is what remains after ALL opportunity cost associated with production, the opportunity cost incurred by ALL factors of production, is deducted from the revenue generated by the production.

  Economic profit is the "conceptually correct" notion of profit used in economics. If profit is revenue minus cost, then economic profit is THE measure of profit.



• Normal Profit: The last notion of profit is the opportunity cost of using entrepreneurial abilities in the production of a good, or the profit that could have been received by entrepreneurship in another business venture. Like the opportunity costs of other resources, normal profit is deducted from revenue when determining economic profit. It is, however, never included as an accounting cost when accounting profit is computed.

Economic Profit and Rent