The economic profit calculator is a tool that helps you estimate profit from an economic perspective. By applying the economic profit formula, you might be able to make better economic decisions in certain situations.

Read on to learn how to calculate economic profit, what is the economic profit definition, and understand the difference between accounting profit vs. economic profit.

What is economic profit? - the economic profit definition

If you've ever thought about setting up a business, one of the first questions you asked yourself is probably "What would be my profit?" There are two crucial elements of profit: revenue and cost.

Let's consider, for example, you're thinking about setting up an ice-cream shop. To calculate the total revenue in such a case is relatively simple: you need to multiply the amount of ice-creams sold by their prices over a given period. As you might think, profit is part of the revenue - that is the revenue which remains after paying out all the costs. This includes the cost of the ice-cream machine, the price of leasing out (or buying) the shop, and the various ingredients you will use. You can measure these costs, called explicit costs, easily as they take the form of real money.

There are, however, other costs which might be less obvious. Let's suppose you are also a professional programmer, and your hourly wage at your previous job was 100 dollars. Therefore, for every hour you work as an ice-cream seller, you would give up this 100 dollars of income, which is also part of your cost: it's an implicit cost.

Therefore, the total cost you need to consider is the sum of your explicit and implicit costs, which is the total opportunity cost including both the cost of the resource (explicit) and the cost of giving up the best alternative use of the resource (implicit). Thus, the economic profit definition is the part of the revenue which is greater than the sum of explicit and implicit costs.

It's easy to see how the implicit cost may change your decision about opening your business. If a company offers you an hourly wage of 300 dollars instead of a 100, you may decide to not set up the business, and instead continue working as a programmer.

How to calculate economic profit - the economic profit formula

So, as you now know what economic profit is, let's see how to calculate economic profit. Relying on the previously outlined example, the economic profit formula takes the following form:

economic profit = total revenue - total opportunity cost

economic profit = total revenue - (explicit costs + implicit costs)

where:

  • total revenue is your total income or gain;
  • explicit cost is the cost that requires you to spend money; and
  • implicit costs is the cost that doesn't require you to spend money.

That's not all! If you want to learn what is accounting profit vs. economic profit, you can explore this topic in the next section. This may be even more helpful to you in your economic decisions.

Accounting profit vs. economic profit

After reading the economic profit definition, you may have already guessed what profit means to an economist and what it means to an accountant. Accountants work with rough numbers: they take into consideration only the explicit costs. Therefore, accounting profit is the total revenue remaining after deducting the explicit costs of a firm. The economic profit, however, considers all opportunity costs, including the implicit costs that don't require an outlay of money.

An essential implicit cost to take into consideration when setting up a business is the opportunity cost of the financial capital used in an investment. Let's assume you have 100,000 dollars in your savings account which you can use to set up your ice-cream shop. The bank provides a 4.5 percent interest rate, compounding monthly, which means that if you leave your money in your savings account, you could earn 4,594 dollars in a year. This amount of money is the opportunity cost of your savings, which doesn't matter when computing accounting profit, but is essential when working out economic profit.

Tibor Pal, PhD candidate