Economic Profit Calculator
Economic profit is a measure used in economics to calculate the profit or loss of a firm when considering *both* explicit costs (out-of-pocket expenses) and implicit costs (opportunity costs).
Enter the Total Revenue, Total Explicit Costs, and Total Implicit Costs to calculate the Economic Profit.
Enter Financial Data
Understanding Economic Profit & Formulas
What is Economic Profit?
Economic profit is the difference between total revenue and total costs, including both explicit and implicit costs. Explicit costs are direct, out-of-pocket expenses. Implicit costs are the opportunity costs of using resources the firm already owns, like the owner's time or capital.
Unlike accounting profit, which only subtracts explicit costs from total revenue, economic profit provides a more complete picture by factoring in what the business owner or resources could have earned elsewhere.
Economic Profit Formula
The formula is straightforward:
Economic Profit = Total Revenue - Total Explicit Costs - Total Implicit Costs
Alternatively, since Accounting Profit = Total Revenue - Total Explicit Costs, we can say:
Economic Profit = Accounting Profit - Total Implicit Costs
Significance of Economic Profit
- Positive Economic Profit: The business is earning more than enough to cover all its explicit costs *and* the opportunity costs of the resources used. This suggests the business is utilizing its resources in the most profitable way compared to alternative uses.
- Zero Economic Profit (Break-even): The business is covering all its explicit costs and all its implicit costs. This means the business is earning just enough to keep its resources employed in their current use, as they could earn a similar return elsewhere. This is often called "normal profit" in economics.
- Negative Economic Profit (Economic Loss): The business is not covering all its costs, including opportunity costs. The resources used could earn a higher return in an alternative venture. This suggests the business may not be the best use of those resources.
Calculating economic profit helps businesses make better long-term decisions about resource allocation and whether to continue in a particular market.
Economic Profit Examples
Click on an example to see the calculation:
Example 1: Small Business with Positive Economic Profit
Scenario: A graphic designer quits a job paying $50,000/year to start their own freelance business. They invest $10,000 of their savings, which could have earned 5% interest elsewhere.
Known Values:
- Total Revenue: $80,000
- Total Explicit Costs (software, rent, etc.): $20,000
- Total Implicit Costs (Forgone salary + lost interest): $50,000 + ($10,000 * 0.05) = $50,000 + $500 = $50,500
Calculation: Economic Profit = $80,000 - $20,000 - $50,500
Result: Economic Profit = $9,500
Conclusion: The designer is making a positive economic profit, meaning their freelance business is financially more rewarding than their previous job and alternative investment.
Example 2: Restaurant Breaking Even Economically
Scenario: A couple opens a restaurant. They previously earned combined salaries of $120,000/year. They invested $100,000 from savings that could earn 4% interest.
Known Values:
- Total Revenue: $500,000
- Total Explicit Costs (food, wages, rent, etc.): $376,000
- Total Implicit Costs (Forgone salaries + lost interest): $120,000 + ($100,000 * 0.04) = $120,000 + $4,000 = $124,000
Calculation: Economic Profit = $500,000 - $376,000 - $124,000
Result: Economic Profit = $0
Conclusion: The restaurant is breaking even economically. They are covering all costs, including paying themselves and their investment a return equivalent to what they could earn elsewhere. They earn "normal profit".
Example 3: Small Consulting Firm with Economic Loss
Scenario: An engineer starts a consulting firm. Her previous salary was $90,000/year. She used $50,000 of savings that could earn 6%.
Known Values:
- Total Revenue: $150,000
- Total Explicit Costs (office, supplies, etc.): $55,000
- Total Implicit Costs (Forgone salary + lost interest): $90,000 + ($50,000 * 0.06) = $90,000 + $3,000 = $93,000
Calculation: Economic Profit = $150,000 - $55,000 - $93,000
Result: Economic Profit = -$1,000
Conclusion: The consulting firm is making an economic loss. Although it might show an accounting profit ($150k - $55k = $95k), the economic profit is negative, indicating the engineer would be financially better off returning to her previous job.
Example 4: Tech Startup Investment
Scenario: A tech startup receives investment. The founders forgo combined potential salaries of $200,000/year. Initial investment (explicit cost this year) is $500,000. The investors expect a 10% return on their $1,000,000 investment this year (implicit cost to the firm).
Known Values:
- Total Revenue: $300,000
- Total Explicit Costs (including investment spent this year): $500,000 + $150,000 (operating costs) = $650,000
- Total Implicit Costs (Forgone salaries + investor required return): $200,000 + ($1,000,000 * 0.10) = $200,000 + $100,000 = $300,000
Calculation: Economic Profit = $300,000 - $650,000 - $300,000
Result: Economic Profit = -$650,000
Conclusion: The startup is currently operating at a significant economic loss, which is common in early-stage, high-growth companies as they prioritize market share over immediate profitability relative to opportunity costs.
Example 5: Farmer's Economic Profit
Scenario: A farmer uses his own land (worth $500,000, could be rented for $20,000/year) and his own labor (could earn $30,000/year elsewhere).
Known Values:
- Total Revenue (from crops): $150,000
- Total Explicit Costs (seeds, fertilizer, equipment maint.): $70,000
- Total Implicit Costs (Forgone rent + forgone wages): $20,000 + $30,000 = $50,000
Calculation: Economic Profit = $150,000 - $70,000 - $50,000
Result: Economic Profit = $30,000
Conclusion: The farmer earns a positive economic profit, suggesting farming is a better use of his land and labor than the alternatives considered.
Example 6: Existing Business Evaluation
Scenario: An established small business owner evaluates their performance. They've invested $300,000 of their own capital (opportunity cost 3%). Their potential alternative salary is $75,000.
Known Values:
- Total Revenue: $600,000
- Total Explicit Costs: $480,000
- Total Implicit Costs (Forgone salary + lost interest): $75,000 + ($300,000 * 0.03) = $75,000 + $9,000 = $84,000
Calculation: Economic Profit = $600,000 - $480,000 - $84,000
Result: Economic Profit = $36,000
Conclusion: The business is generating a positive economic profit, confirming it's a good use of the owner's time and capital compared to their next best alternatives.
Example 7: Zero Implicit Costs (Accounting Profit = Economic Profit)
Scenario: A large corporation calculates profit. For simplicity, assume no significant implicit costs like owner-provided capital/labor or alternative uses of major assets beyond their book value and depreciation.
Known Values:
- Total Revenue: $10,000,000
- Total Explicit Costs: $8,000,000
- Total Implicit Costs: $0 (or negligible, assuming all significant factors are captured as explicit costs)
Calculation: Economic Profit = $10,000,000 - $8,000,000 - $0
Result: Economic Profit = $2,000,000
Conclusion: When implicit costs are zero, economic profit equals accounting profit. This is often a simplifying assumption, but shows the relationship.
Example 8: Startup with High Explicit Costs, Low Revenue
Scenario: A startup in its first year has high setup costs. The founder could earn $70,000 elsewhere. They invested $20,000 of their savings (opportunity cost 5%).
Known Values:
- Total Revenue: $30,000
- Total Explicit Costs: $95,000
- Total Implicit Costs (Forgone salary + lost interest): $70,000 + ($20,000 * 0.05) = $70,000 + $1,000 = $71,000
Calculation: Economic Profit = $30,000 - $95,000 - $71,000
Result: Economic Profit = -$136,000
Conclusion: The startup is experiencing a large economic loss. This is expected in early stages but highlights the need for future growth to cover these costs and become economically viable.
Example 9: Opportunity Cost of Using Owned Building
Scenario: A business operates in a building they own. They could rent it out for $15,000/year. The owner's forgone salary is $60,000.
Known Values:
- Total Revenue: $250,000
- Total Explicit Costs (excluding rent): $160,000
- Total Implicit Costs (Forgone rent + forgone salary): $15,000 + $60,000 = $75,000
Calculation: Economic Profit = $250,000 - $160,000 - $75,000
Result: Economic Profit = $15,000
Conclusion: The business is making a positive economic profit, even when considering the alternative use of the building and the owner's time.
Example 10: Zero Total Revenue
Scenario: A hobby project is being evaluated as a potential business. There's no revenue yet, but there are explicit costs for materials and time/capital opportunity costs.
Known Values:
- Total Revenue: $0
- Total Explicit Costs: $500
- Total Implicit Costs: $1,000 (opportunity cost of time/small investment)
Calculation: Economic Profit = $0 - $500 - $1,000
Result: Economic Profit = -$1,500
Conclusion: As expected, with no revenue, the project incurs an economic loss equal to the sum of explicit and implicit costs. This calculation helps show the financial hurdle to overcome if it were to become a viable business.
Frequently Asked Questions about Economic Profit
1. What is Economic Profit?
Economic profit is the difference between total revenue and the sum of both explicit costs (actual payments) and implicit costs (opportunity costs).
2. What's the formula for Economic Profit?
Economic Profit = Total Revenue - Total Explicit Costs - Total Implicit Costs.
3. How is Economic Profit different from Accounting Profit?
Accounting profit only subtracts explicit costs from total revenue. Economic profit subtracts *both* explicit and implicit costs. Economic profit is usually lower than accounting profit because it includes opportunity costs.
4. What are Explicit Costs?
Explicit costs are direct, out-of-pocket expenses like wages, rent, utilities, materials, and taxes – costs that involve a monetary payment to a third party.
5. What are Implicit Costs?
Implicit costs are the opportunity costs of using resources that the firm already owns. Examples include the forgone salary of the owner working in the business instead of elsewhere, or the forgone interest/return on the owner's capital invested in the business.
6. What does it mean to have Zero Economic Profit?
Zero economic profit means the business is covering all its explicit costs and all its implicit costs. This is often referred to as earning a "normal profit" because the firm is earning just enough to keep its resources in their current use, as they could earn a comparable return elsewhere.
7. Why is Economic Profit important?
Economic profit is a better indicator of a firm's long-term sustainability and efficiency in using resources. It helps evaluate if the business is the *best* use of the owner's time, capital, and other resources compared to alternative opportunities.
8. Can a business have accounting profit but economic loss?
Yes, this is common. A business might have enough revenue to cover explicit costs (accounting profit), but not enough to also cover the opportunity costs (implicit costs). This results in an economic loss.
9. What units should I use for inputs?
Use a consistent currency unit (e.g., USD, EUR, GBP) for Total Revenue, Explicit Costs, and Implicit Costs. The resulting Economic Profit will be in the same currency unit.
10. How is opportunity cost determined for implicit costs?
Opportunity cost is the value of the next-best alternative forgone. For labor, it's the salary the owner could earn elsewhere. For capital, it's the return the capital could earn in a different investment with similar risk.
