In economic principles classes, students learn the difference between accounting profit and economic profit. Accounting profit is what is usually understood when discussing “profit” and is total revenue minus monetary costs. This is recorded as “profit” at the bottom of the financial statement.
Economic benefits have a broader meaning. Remember that for economists, “cost” is a technical term. It is the most valuable alternative that has not been implemented. This includes both monetary costs and alternative uses of resources, known as implicit costs. Economic profit is therefore total revenue minus total costs (both monetary and implicit costs). Implicit costs don’t show up in financial reports, but they’re still essential to life decisions.
The accounting profit may be positive (that is, you are making money), but the economic profit may be negative (that is, the resource has a better alternative use). In that case, it makes economic sense to realign resources toward higher-value uses.
An example of economic and accounting benefits is illustrated in “The Rise of the Cajun Mariners: The Race for Big Oil” by Woody Fargow. Woody’s book follows four Cajun families as they rise from poverty to powerhouses on the bayou’s oil boats. One such family was the Orgerons.
For the purposes of this post, Orgeron refers to his father, Juan, and his two sons, Herman “Bouillian” and Bobby. During World War II, Juan operated the Herman J, a boat that serviced oil rigs in the Gulf of Mexico. After the war, disputes over rights to submerged minerals escalated between coastal states and the federal government, known as the tidal flat dispute. There wasn’t much need for oil boats during the conflict, so Juan sold the Herman J and returned to his traditional source of income: catching muskrats.
Hunting muskrats was a good job for Juan. It allowed him to buy a Herman J, put food on the table, and give his sons at least a rudimentary education. After the war, muskrat prices were high and labor costs were relatively low. His two sons worked for him without pay (Bouillian full-time and Bobby when he was not at school) (page 23). Juan did indeed make an accounting profit. But was he reaping financial benefits? Could he have allocated his resources (labor) better? Bouillian certainly thought so.
“But in 1946, Bouillian reminded him: [Juan] Trapping was a good life, but working in the oil fields was a better life. Bouillian told his father that things were improving and persuaded him to buy a 36-foot wooden crew boat with twin Chrysler engines. This boat served Texaco out of Lafitte, 25 miles northeast of Golden Meadow. [their home] (page 23).
Mr. Bouillian believed that the economic cost of maintaining an entire workforce on muskrat trapping leases was greater than the income it would bring to his family. Therefore, it makes sense to reallocate resources. Juan agreed, bought a new boat, appointed Bouillian as captain, and resumed service to the oil industry. By recognizing that accounting profits are positive but economic profits are negative, Juan and Bouilien were able to increase their happiness (their family is much wealthier) and increase their profits. But with the insight of an economist, Huang intuitively understood that life happens at the margins. He did not reallocate all resources to oil. He kept Bobby on the Muskrat lease. Bobby wasn’t too thrilled about the deal, but that’s a story for another day.
The idea of economics is descriptive and prescriptive. This book teaches you how people make decisions and shows you how to improve your decision-making skills. Not everyone is as lucky as Orgeron (they were certainly skilled, but there is also luck involved in success). They were in the right place at the right time to take advantage of the oil industry. But the ideas of economics show us how to improve our lives, even if only in small increments. But thanks to the power of compound interest, incremental improvements can lead to significant profits. Recognizing financial costs (even if they are temporary and indescribable) and opportunities is the key to improving your financial position.
