In any economics class, one of the key concepts students explore is the distinction between accounting profit and economic profit. Accounting profit, commonly referred to as “profit,” is calculated by subtracting monetary costs from total revenue. This figure is what you typically see at the bottom of an accounting statement labeled as “profit.”
Economic profit, on the other hand, encompasses a broader definition. Economists use the term “cost” to describe the next best alternative that is forgone, meaning it includes both monetary costs and alternative uses of your resources—these are known as implicit costs. Consequently, economic profit is calculated by subtracting total costs (both monetary and implicit) from total revenue. While implicit costs are not reflected in accounting statements, they play a crucial role in making informed life decisions.
It is possible to have a positive accounting profit (indicating financial success) while experiencing a negative economic profit (suggesting there are more valuable ways to utilize your resources). In such circumstances, the rational choice would be to redirect your resources to a more profitable endeavor.
A practical illustration of accounting versus economic profit is presented in The Rise of the Cajun Mariners: The Race for Big Oil by Woody Falgoux. This book chronicles the journey of four Cajun families as they rise to prominence as major oil boat owners on the bayou, including the story of the Orgerons.
In this context, the Orgeron family consists of Juan, the father, and his two sons, Herman “Bouillien” and Bobby. During World War II, Juan operated a boat named the “Herman J,” which served oil rigs in the Gulf of Mexico. However, after the war, the Tidelands Dispute over submerged mineral rights between coastal states and the federal government diminished the demand for oil boats. As a result, Juan sold the Herman J and returned to his previous livelihood of muskrat trapping.
Muskrat trapping proved to be a viable business for Juan, enabling him to buy the Herman J, feed his family, and educate his sons at least minimally. The post-war prices for muskrat were favorable, and his labor costs were low since his sons worked for him without pay (Bouillien full-time and Bobby when he wasn’t in school) (pg. 23). While Juan certainly made an accounting profit, the question remained: Was he achieving economic profit? Bouillien believed there was a more efficient use of their resources:
“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 recognized that the economic cost of maintaining all their labor in muskrat trapping exceeded the revenue it generated. Therefore, reallocating their resources made practical sense. Juan concurred, invested in a new boat, appointed Bouillien as captain, and resumed operations in the oil industry. By understanding that their accounting profit was positive but their economic profit was negative, Juan and Bouillien successfully enhanced their well-being, eventually leading to significant wealth. However, Juan, with his keen economic insight, wisely chose not to allocate all their resources to oil; he retained Bobby on the muskrat leases. Bobby was less than enthused about this decision, but that’s a story for another time.
The economic perspective is both descriptive and prescriptive. It explains how individuals make decisions and highlights strategies for improving decision-making skills. Not everyone can replicate the fortunate circumstances of the Orgerons; while their skills were essential, luck also played a role in their success. Nevertheless, the economic way of thinking can indeed enhance our lives, even if only in small increments. Over time, these incremental improvements can yield substantial gains due to the compounding effect. Recognizing economic costs—despite them sometimes being intangible—and identifying opportunities is crucial to elevating one’s economic situation.
