Economics, 3rd Edition

Economists versus Accountants

Economists include all opportunity costs when analysing a firm, whereas accountants measure only explicit costs. Therefore, economic 

profit is smaller than accounting profit.

Revenue

Revenue

Total

opportunity

costs

How an economist

views a firm

Economic

profit

Accounting

profit

Implicit

costs

Explicit

costs

Explicit

costs

How an accountant

views a firm

E

i t

FIGURE 6.6

Figure 6.6 summarizes this difference. Notice that because the accountant ignores the implicit costs, 

accounting profit is usually larger than economic profit. For a business to be profitable from an econ-

omist’s standpoint, total revenue must cover all the opportunity costs, both explicit and implicit.

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154  PART 2  SUPPLY AND DEMAND: HOW MARKETS WORK

it is worth the Grundy Farm producing this extra milk. Once the Grundy Farm has reached 5 litres of milk, 

however, the situation is very different. The sixth litre would have marginal revenue of 

€6 and marginal cost 

of 

€7, so producing it would reduce profit by €1 (from €7 to €6). It does not make sense for the Grundy Farm 

to produce the sixth litre and so, as a result, there is no incentive for the Grundy’s to produce beyond 5 litres.

This is another example of thinking at the margin. If marginal revenue is greater than marginal cost – as 

it is at 1, 2 or 3 litres – it is worth the Grundy’s increasing the production of milk; even making a decision 

to increase production from the third to the fourth litre is worth doing since the MC and MR are the same 

at this point and as a result the profit level is neither increased nor decreased. If marginal revenue is less 

than marginal cost, as it is at 5, 6 or 7 litres, the Grundy’s should decrease production. If the Grundy’s 

think at the margin and make incremental adjustments to the level of production, they are naturally led 

to produce the profit-maximizing quantity. The profit maximizing output occurs, therefore, at the output 

where MR 

= MC.