Economic profit equals a firm's total revenues less its total economic costs. Economic costs are the sum of explicit costs and implicit costs. Explicit costs represent actual payments to other parties in return of a resource while implicit costs are the economic profits sacrificed in not undertaking the resource's alternate use.
Unlike accounting profit which equals total revenues minus the explicit costs only, economic profit equals accounting profit minus the implicit costs. In economics, opportunity cost is also treated as a cost and subtracted from revenues to arrive at the profit.
The concept of economic profit is finance is a little different than the concept in economics. In finance economic profit equals the economic value added which equals net operating profit after tax minus the product of weighted average cost of capital and capital employed.
|Economic Profit = Total Revenues − Explicit Costs − Implicit Costs|
|Economic Profit = Accounting Profit − Implicit Costs|
Stark Industries' accounting profit for the year ended 31 December 2012 amounted to $3,130 million. CEO Tony Stark could have earned an amount of $230 million by signing up for different movies instead of running the stark industries. Instead of developing the Iron Man outfit, the resources could have been used to develop robots for medical use. The project could have earned a profit of $1,500 million. Find Stark Industries' economic profit.
Economic profits equals total revenues minus the sum of explicit costs and implicit costs. Since explicit costs are already subtracted when arriving at the accounting profit, we can find economic profit by subtracting the implicit costs from the accounting profit.
Implicit costs in this situation are the opportunity cost of CEO Tony Stark's time which amounts to $230 million plus the economic profit of $1,500 million from the alternate use of the company assets. Total implicit costs amount to $1,730 million. Economic profit of Stark Industries is hence $1,400 million ($3,130 million minus $1,730 million).
Written by Obaidullah Jan