What is the formula for calculating economic profit?

The formula for calculating economic profit is defined as total revenue minus both explicit costs and implicit costs. This approach recognizes the full spectrum of costs associated with a business operation.

Explicit costs are the direct, out-of-pocket expenses incurred in the production of goods or services, such as wages, rent, and materials. Implicit costs, on the other hand, represent the opportunity costs of using resources in one way rather than in their next best alternative, such as the income a business owner could have earned working elsewhere instead of running their own business.

Therefore, to arrive at economic profit, it is essential to deduct both types of costs from the total revenue generated by the business. This comprehensive view of costs provides a more accurate picture of a firm's profitability as it reflects not only the financial outlay (explicit) but also the lost opportunities (implicit) associated with the capital and resources utilized. Thus, the correct formula encapsulates the idea that economic profit is about assessing the true profitability of a business after accounting for all costs involved.