Economic Profit vs Opportunity Cost: Difference and Comparison

Both these two terms are different from each other.  And in this article, we will talk about both these terms in detail and gain many new bits of knowledge.

And also see the differences between the two and some similarities. Both terms vary according to different scenarios and perspectives.

Key Takeaways

1. Economic profit includes explicit and implicit costs, while opportunity cost is only concerned with the value of the next best alternative.
2. Firms aim to maximize economic profit, which can be positive, negative, or zero, whereas opportunity cost represents a trade-off in decision-making.
3. Understanding both concepts helps businesses make more informed decisions on resource allocation and investments.

Economic Profit vs Opportunity Cost

Economic profit refers to the difference between the total revenue a business earns and the total cost of all resources used to produce its products or services.  Opportunity cost refers to the cost of the next best alternative foregone when a choice is made. Opportunity cost is important to consider when making decisions.

Economic profit is the disagreement between the revenue a company has received from its outputs and the opportunity cost of its inputs.

Calculating economic profit is one of the ways a company understands whether business decisions are good or not. This term comes from a commercial entity.

An individual or investor can represent opportunity costs as potential benefits. Opportunity costs are derived from an option. It is a foregone benefit.

The costs and benefits of every option must be considered and weighed against the others. Opportunity costs and guide individuals and organizations.

Comparison Table

Parameters of Comparison	Economic Profit	Opportunity Costs
Definition	Economic profit is used for internal analysis.	It is a profit that business misses out on when choosing between alternatives.
Analysis	Economic profit used for internal analysis.	It is used for deeper analysis.
Type	Economic profit is the Explicit cost	Opportunity costs are Implicit cost
Refers to	Economic profit refers to the Total revenue	Opportunity costs refer to the Revenue generated
Advantages	Economic profit Helps rank all opportunities	Opportunity costs give Awareness of lost opportunities.

What Is Economic Profit?

Economic profit is the disagreement between the revenue a commercial entity receives from the output and the opportunity costs of its input.

Economic profit takes into account both firm’s implicit and explicit costs. Accounting profit differs from economic profit because additional implicit costs are included.

Economists or business people check or view the economic profits with expected profits.

Here average profit men cover the implicit and explicit costs of a person(investor, owner, manager) who funds it.  When profit was not present, these parties took better advantage by withdrawing their funds.

Another name for Economic profit is also an excess profit because profits remain after covering implicit and explicit costs.

Business owners prefer average profit, and it is necessary to run their business. The markets are not in competition and have significant barriers to entry only where economic gain arises.

Economic profit becomes non-existent when there is no incentive for firms. When a company reaches a long-run equilibrium, it does not make any monetary profit.

But if economic profits are there, so there would be an incentive for new firms. Uncompetitive markets have more privileges of financial gain. 

What is Opportunity Cost?

Microeconomic theory tells us that the opportunity costs of a particular activity are the loss of value or profit incurred by engaging in that activity.

It is the potential benefit when an investor, individual, and business owner misses out when choosing one alternative. Opportunity costs can easily be overlooked.

The opportunity allows better decision-making when a business or individual chooses one investment over another. It is driven by an option that would have been a foregone benefit.

For evaluating opportunity costs, options of every benefit must be considered and weighed against the others.  Opportunity costs can also guide individuals and organizations to make better decisions.

There is a formula for the calculation of opportunity costs, i.e. Opportunity Cost = FO – CO here, FO means the return on the best-forgone option, and CO means the return on the chosen option.

In this formula, we simply calculate the difference between expected returns.

When financial reports fail to include opportunity costs, business owners frequently use the notion to make informed judgments when faced with several possibilities.

When evaluating a company’s capital structure, the analysis of opportunity costs is crucial. Some individuals confuse sunk costs with opportunity costs, although they are different. 

Main Differences Between Economic Profit And Opportunity Costs

1. Economic profit has many advantages, such as it measures success and efficiency, whereas opportunity cost causes you to consider the reality when choosing among options.
2. The disadvantages of economic profit were that it is difficult to estimate, whereas opportunity costs take too much time to calculation, and there is also a lack of accounting.
3. Economic profit shows the difference between revenue obtained, whereas opportunity costs show us the potential benefits.     
4. Economic profit is used for internal analysis, whereas opportunity costs are used for deeper analysis.         
5. The economic profit comes from subtracting total revenue from explicit and opportunity costs, whereas Opportunity costs are the difference between the option not chosen and the chosen option.            

References  

1. https://www.bostonfed.org/-/media/Documents/neer/neer498c.pdf             

Last Updated : 13 July, 2023