In any principles of economics class, students learn the difference between accounting profit and economic profit. Accounting profit, which is what one typically understands when discussing “profit,” is total revenue minus your monetary costs. It is what appears on the bottom line of an accounting statement as “profit.”
Economic profit is a broader term. Recall that, for economists, “cost” is a term of art: it is the highest-valued alternative not undertaken. This includes both monetary costs and alternative uses of your resources, often called implicit costs. Economic profit, thus, is total revenue minus total costs (both your monetary and your implicit costs). Implicit costs do not show up on an accounting statement, yet they are still vital to making life decisions.
It is possible for accounting profit to be positive (i.e., you are making money), but economic profit is negative (i.e., there are better alternative uses for your resources). In that case, the economically rational thing to do would be to reorganize your resources toward the higher-valued use.
A real-life example of economic and accounting profit is discussed in The Rise of the Cajun Mariners: The Race for Big Oil by Woody Falgoux. Woody’s book follows four Cajun families as they rise from humble beginnings to become major oil boat barons on the bayou. One such family was the Orgerons.
The Orgerons, for the purposes of this post, were the father, Juan, and his two sons, Herman “Bouillien” and Bobby. During World War 2, Juan ran a boat, the “Herman J,” that serviced the oil rigs in the Gulf of Mexico. After the war, a dispute over submerged mineral rights flared between the coastal states and the federal government, known as the Tidelands Dispute. During this dispute, there wasn’t much need for oil boats, so Juan sold the Herman J and returned to his traditional source of income, muskrat trapping.
Muskrat trapping was a good business for Juan. It allowed him to purchase the Herman J, put food on the table, and put his sons through at least rudimentary schooling. The price of muskrat post-war was high and he had relatively low labor costs. His two sons worked for him (Bouillien full-time, Bobby when not in school) at no salary (pg. 23). Juan was certainly making accounting profit. But was he making economic profit? Was there a better allocation of his resources (labor)? Bouillien certainly thought so:
“But then in 1946, Bouillien reminded him [Juan] that while trapping was a good living, the oilfield was a better one. Bouillien told his father things were picking up and convinced him to buy a 36-foot wooden crew boat with twin Chrysler engines, which was working for Texaco out of Lafitte, twenty-five miles to the northeast of Golden Meadow [their home] (pg. 23).”
Bouillien saw that the economic cost of keeping all their labor on the muskrat trapping leases was greater than the revenue it brought in for the family. It made sense, then, to reallocate their resources. Juan agreed, bought a new boat, made Bouillien the captain, and resumed servicing the oil industry. By recognizing their accounting profit was positive but their economic profit was negative, Juan and Bouillien were able to increase their well-being (the family would become quite wealthy) and profit. But, ever the man with an economist’s insight, Juan intuitively understood that life happens at the margins. He did not reallocate all his resources to oil. He kept Bobby on the muskrat leases. Bobby was less-than-thrilled with that arrangement, but that is a story for another time.
The economic way of thinking is both descriptive and prescriptive. It teaches both how people make decisions and shows how one can improve their decision-making skills. Not all can be as lucky as the Orgerons (they certainly were skilled, but luck plays a role in success, too). They were in the right place at the right time to capitalize on the oil industry. But the economic way of thinking does show how we can improve our lives, even if just incrementally. But incremental improvements can lead to substantial gains, thanks to the power of compounding. Recognizing economic costs (even when they are ephemeral and inarticulable) and opportunities is key to improving one’s economic position.
