although the business makes an accounting profit of $35,000, its economic profit is
actually negative. This means that Babette would be better off financially if she closed
the restaurant and devoted her time and capital to something else. If, however, some
of Babette’s cost should fall sufficiently, she could earn a positive economic profit. In
that case, she would be better off financially if she continued to operate the restau-
rant. For instance, consider the column titled Case 2: here we assume that what Ba-
bette could earn as a chef employed by someone else has dropped to $30,000 (say, due
to a soft labor market). In this case, her economic profit is positive: she is earning
more than her explicit and implicit costs and she should keep her restaurant open.
In real life, discrepancies between accounting profit and economic profit are ex-
tremely common. As the FYI above explains, this is a message that has found a recep-
tive audience among real-world businesses.
Normal Profit
In the example above, when Babette is earning an economic profit, her total revenue
is higher than the sum of her implicit and explicit costs. This means that operating
her restaurant makes Babette better off financially than she would be using her re-
sources in any other activity. When Babette earns a negative economic profit (which
can also be described as a loss), it means that Babette would be better off financially
if she devoted her resources to her next best alternative. As this example illustrates,
economic profits signal the best use of resources. A positive economic profit indi-
cates that the current use is the best use of resources. A negative economic profit in-
dicates that there is a better alternative use for resources.
module 52 Defining Profit 533
Farming in the Shadow of Suburbia
Beyond the sprawling suburbs, most of New
England is covered by dense forest. But this is
not the forest primeval: if you hike through the
woods, you encounter many stone walls, relics
of the region’s agricultural past when stone
walls enclosed fields and pastures. In 1880,
more than half of New England’s land was
farmed; by 2009, the amount was down to
10%.
The remaining farms of New England are
mainly located close to large metropolitan
areas. There farmers get high prices for their
produce from city dwellers who are willing to
pay a premium for locally grown, extremely
fresh fruits and vegetables.
But now even these farms are under eco-
nomic pressure caused by a rise in the implicit
cost of farming close to a metropolitan area. As
metropolitan areas have expanded during the
last two decades, farmers increasingly ask
themselves whether they could do better by
selling their land to property developers.In 2009, the average value of an acre of
farmland in the United States as a whole was
$2,100; in Rhode Island, the most densely pop-
ulated of the New England states, the average
was $15,300. The Federal Reserve Bank of
Boston has noted that “high land prices put in-
tense pressure on the region’s farms to gener-
ate incomes that are substantial enough to
justify keeping the land in agriculture.” The im-
portant point is that the pressure is intense even
if the farmer owns the land because the land is
a form of capital used to run the business.Maintaining the land as a farm instead of selling
it to a developer constitutes a large implicit cost
of capital. A fact provided by the U.S. Depart-
ment of Agriculture (USDA) helps us put a dollar
figure on the portion of the implicit cost of capi-
tal due to development pressure for some
Rhode Island farms. In 2004, a USDA program
designed to prevent development of Rhode Is-
land farmland by paying owners for the “devel-
opment rights” to their land paid an average of
$4,949 per acre for those rights alone. By 2009,
the amount had risen to $15,357.
About two-thirds of New England’s farms re-
maining in business earn very little money. They
are maintained as “rural residences” by people
with other sources of income—not so much be-
cause they are commercially viable, but more
out of a personal commitment and the satisfac-
tion these people derive from farm life. Although
many businesses have important implicit costs,
they can also have important benefits to their
owners that go beyond the revenue earned.fyi
Michael S. Lewis/National Geographic/Getty Images