Economic profit is a concept that differs from accounting profit and is defined as the difference between total income minus costs and opportunity costs associated with the income received. Opportunity costs are the price of a lost opportunity; when, for example, an investor decides to invest money and other resources in one business, he misses opportunities associated with other businesses (“What is economic profit,” 2021). This paper aims to explain the sources of economic profit, both internal and external, to the firm.
There are two schools or perspectives on where the main sources of economic profit come from. The Industrial Organization or IO perspective assumes that the industry is definitive regarding the opportunities for the businesses’ economic profit since some industries are just more profitable than the others. This perspective utilizes Porter’s Five Forces theory which defines the critical elements of the industry that make it more or less profitable (Froeb et al., 2018). Therefore, the most potentially profitable industries are characterized by high barriers to entry, low buyer power, low supplier power, a low threat from substitutes, and low levels of rivalry between existing firms.
Another school or perspective is called Resource-Based View or RBV. This approach implies that some businesses within one particular industry operate better than others due to their superior resources. From this perspective, the resources are defined as the tangible and intangible assets firms use to meet their goals and implement their business strategies. Examples of tangible resources are equipment, financial capital, and real estate; intangible resources are knowledge, brand, and organizational culture. Importantly, RBV assumes that resources are immobile or resistant to copying and transferring, whereas more valuable and rare resources lead to superior performance or the ability to bring above-average profit.
Thus, the sources of economic profit, both internal and external to the firm, were explained. Economic profit is something different from accounting profit since it covers opportunity costs related to the particular business. Internal economic profit resources are considered from the Resource-Based View, which implies that the companies with the rare and valuable resources can have superior performance. External economic profit resources are determined by the industry opportunities.
References
Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial economics – a problem-solving approach (5th ed.). Boston, MA: Cengage Learning.
What is economic profit? (2021). Web.