Accounting vs.
Economics: An Overview
Accounting and economics both involve plenty of number-crunching. But accounting is a profession devoted to
recording, analyzing, and reporting income and expenses, while economics is a branch of the social sciences that is
concerned with the production, consumption, and transfer of resources.
KEY TAKEAWAYS
Accountants track the flow of money for businesses and individuals.
Economists track the larger trends that drive money and the resources that money represents.
Both help businesses and governments plan for the future, make sound financial decisions, and set fiscal policies.
Accounting
Most individuals deal with accountants only at tax time. But in the larger business world, accountants are a critical
part of any organization. Their job is to track the flow of money into and out of an organization.
They use various methods to record and analyze budgets, expenses, and revenue and produce financial records
based on the data they have analyzed. Their work is crucial for predicting the financial impact of any
recommended change or potential future event on a business.
Accountants' books are by nature a historical record of an individual or organization's financial life for a specific
period of time. The accounting standards, known as GAAP, are critical for tax compliance and for accurate financial
reporting to shareholders.
In modern times, accounting operates according to principles of relevance, timeliness, reliability, comparability,
and consistency of information or reports. Globally accepted accounting standards are followed in order to enable
the exchange of information.
Notably, those standards are followed in quarterly and annual financial reports of publicly-listed corporations.
Accountants' books are by nature a historical record of an individual or organization's financial life for a specific
period of time.
Economics
Economics, broadly speaking, is a field of study concerned with the distribution of resources among people.
Outside academia, economists are involved in analyzing and understanding the way that goods and services are
produced and distributed.
Economists have a critical role in developing economic policies for governments and projecting the impact of policy
and regulatory changes. They are increasingly in demand in financial services and industry, where they interpret
and forecast market trends.
Economics is broadly divided into two areas of study:
Macroeconomics is concerned with the distribution of resources within an ecosystem, such as a nation. It includes
the tracking and study of the many factors that affect how efficiently the economy works, such as the inflation rate
and the productivity rate.
Microeconomics is the study of the behavior of the individual within an economic ecosystem, or of any other single
entity such as a business. It is concerned with the impact of individual decisions on the distribution of resources.
Key Differences
Both accountants and economists help businesses, industries, and governments to strategize and plan, make
sound financial decisions, and set fiscal policies. Professionals in both fields base their analyses and projections on
real-life markets, conditions, and events.
Accounting is the nuts-and-bolts field that tracks the inflow and outflow of money, while economists are typically
more concerned with the big-picture trends that drive money.
Accounting profit is the monetary costs a firm pays out and the revenue a firm receives. ... Accounting profit =
total monetary revenue- total costs. Economic profit is the monetary costs and opportunity costs a firm pays and
the revenue a firm receives. Economic profit = total revenue – (explicit costs + implicit costs).
Key Points
Explicit costs are monetary costs a firm has. Implicit costs are the opportunity costs of a firm’s resources.
Accounting profit is the monetary costs a firm pays out and the revenue a firm receives. It is the bookkeeping
profit, and it is higher than economic profit. Accounting profit = total monetary revenue- total costs.
Economic profit is the monetary costs and opportunity costs a firm pays and the revenue a firm receives. Economic
profit = total revenue – (explicit costs + implicit costs).
Key Terms
explicit cost: A direct payment made to others in the course of running a business, such as wages, rent, and
materials, as opposed to implicit costs, which are those where no actual payment is made.
implicit cost: The opportunity cost equal to what a firm must give up in order to use factors which it neither
purchases nor hires.
economic profit: The difference between the total revenue received by the firm from its sales and the total
opportunity costs of all the resources used by the firm.
accounting profit: The total revenue minus costs, properly chargeable against goods sold.
The term “profit” may bring images of money to mind, but to economists, profit encompasses more than just cash.
In general, profit is the difference between costs and revenue, but there is a difference between accounting profit
and economic profit. The biggest difference between accounting and economic profit is that economic profit
reflects explicit and implicit costs, while accounting profit considers only explicit costs.
Explicit and Implicit Costs
Explicit costs are costs that involve direct monetary payment. Wages paid to workers, rent paid to a landowner,
and material costs paid to a supplier are all examples of explicit costs.
In contrast, implicit costs are the opportunity costs of factors of production that a producer already owns. The
implicit cost is what the firm must give up in order to use its resources; in other words, an implicit cost is any cost
that results from using an asset instead of renting, selling, or lending it. For example, a paper production firm may
own a grove of trees. The implicit cost of that natural resource is the potential market price the firm could receive
if it sold it as lumber instead of using it for paper production.
Accounting Profit
Accounting profit is the difference between total monetary revenue and total monetary costs, and is computed by
using generally accepted accounting principles (GAAP). Put another way, accounting profit is the same as
bookkeeping costs and consists of credits and debits on a firm’s balance sheet. These consist of the explicit costs a
firm has to maintain production (for example, wages, rent, and material costs). The monetary revenue is what a
firm receives after selling its product in the market.
Accounting profit is also limited in its time scope; generally, accounting profit only considers the costs and revenue
of a single period of time, such as a fiscal quarter or year.
Economic Profit
Economic profit is the difference between total monetary revenue and total costs, but total costs include both
explicit and implicit costs. Economic profit includes the opportunity costs associated with production and is
therefore lower than accounting profit. Economic profit also accounts for a longer span of time than accounting
profit. Economists often consider long-term economic profit to decide if a firm should enter or exit a market.
Economic vs. Accounting Profit: The biggest difference between economic and accounting profit is that economic
profit takes implicit, or opportunity, costs into consideration.
Sources and Determinants of Profit
Whether economic profit exists or not depends how competitive the market is, and the time horizon that is being
considered.
LEARNING OBJECTIVES
Describe sources of economic profit
KEY TAKEAWAYS
Key Points
Economic profit = total revenue – ( explicit costs + implicit costs). Accounting profit = total revenue – explicit costs.
Economic profit can be positive, negative, or zero. If economic profit is positive, there is incentive for firms to enter
the market. If profit is negative, there is incentive for firms to exit the market. If profit is zero, there is no incentive
to enter or exit.
For a competitive market, economic profit can be positive in the short run. In the long run, economic profit must
be zero, which is also known as normal profit. Economic profit is zero in the long run because of the entry of new
firms, which drives down the market price.
For an uncompetitive market, economic profit can be positive. Uncompetitive markets can earn positive profits
due to barriers to entry, market power of the firms, and a general lack of competition.
Key Terms
normal profit: The opportunity cost of an entrepreneur to operate a firm; the next best amount the entrepreneur
could earn doing another job.
Economic profit is total revenue minus explicit and implicit (opportunity) costs. In contrast, accounting profit is the
difference between total revenue and explicit costs- it does not take opportunity costs into consideration, and is
generally higher than economic profit.
Economic profits may be positive, zero, or negative. If economic profit is positive, other firms have an incentive to
enter the market. If profit is zero, other firms have no incentive to enter or exit. When economic profit is zero, a
firm is earning the same as it would if its resources were employed in the next best alternative. If the economic
profit is negative, firms have the incentive to leave the market because their resources would be more profitable
elsewhere. The amount of economic profit a firm earns is largely dependent on the degree of market competition
and the time span under consideration.
Competitive Markets
In competitive markets, where there are many firms and no single firm can affect the price of a good or service,
economic profit can differ in the short-run and in the long-run.
In the short run, a firm can make an economic profit. However, if there is economic profit, other firms will want to
enter the market. If the market has no barriers to entry, new firms will enter, increase the supply of the
commodity, and decrease the price. This decrease in price leads to a decrease in the firm’s revenue, so in the long-
run, economic profit is zero. An economic profit of zero is also known as a normal profit. Despite earning an
economic profit of zero, the firm may still be earning a positive accounting profit.
Long-Run Profit for Perfect Competition: In the long run for a firm in a competitive market, there is zero economic
profit. Graphically, this is seen at the intersection of the price level with the minimum point of the average total
cost (ATC) curve. If the price level were set above ATC’s minimum point, there would be positive economic profit; if
the price level were set below ATC’s minimum, there would be negative economic profit.
Uncompetitive Markets
Unlike competitive markets, uncompetitive markets – characterized by firms with market power or barriers to
entry – can make positive economic profits. The reasons for the positive economic profit are barriers to entry,
market power, and a lack of competition.
Barriers to entry prevent new firms from easily entering the market, and sapping short-run economic profits.
Market power, or the ability to affect market prices, allows firms to set a price that is higher than the equilibrium
price of a competitive market. This allows them to make profits in the short run and in the long run. This situation
can occur if the market is dominated by a monopoly (a single firm), oligopoly (a few firms with significant market
control), or monopolistic competition (firms have market power due to having differentiated products).
Lack of competition keeps prices higher than the competitive market equilibrium price. For example, firms can
collude and work together to restrict supply to artificially keep prices high.
Long-Run Profit for Monopoly: In the long run, a monopoly, because of its market power, can set a price above the
competitive equilibrium and earn economic profit. If price were set equal to the minimum point of the average
total cost (ATC) curve, the monopoly would earn zero economic profit. If the price were set lower than the
minimum of ATC, the firm would earn negative economic profit.
