Both these two terms are different from each other. And in this article, we are going to 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.
Economic Profit vs Opportunity Cost
The main difference between Economic profit and opportunity cost is that Economic profit is the revenue received from the sale of an output and the costs of all input used whereas opportunity costs are determined by management. Economic profit is a type of explicit cost whereas opportunity costs are a type of implicit cost.
Economic profit is the disagreement between the revenue a company has received from its outputs and the opportunity cost of its inputs. Calculation of 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 available must be considered and weighed against the others. Opportunity costs and guide individuals and organizations.
Comparison Table Between Economic Profit And Opportunity Costs
| Parameters of Comparison | Economic Profit | Opportunity Costs |
| Definition | It is a profit that comes by subtracting explicit and opportunity costs from revenue. | 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 usually differs from economic profit because additional implicit costs are included.
Economists or businessmen usually check or we can say view the economic profits in conjunction with normal profit. Here normal profit men cover both 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 of Economic profit is also an excess profit because profits remain after implicit and explicit costs are covered.
Business owners prefer normal profit and it is necessary to run their business. The markets which are not in competition and have significant barriers to entry only where the economic profit arises. Economic profit becomes non-existent when there is no incentive for firms. When a company reaches a long-run equilibrium then it does not make any economic profit. But if economic profits are there so there would be an incentive for new firms. Uncompetitive markets have more privilege of economic profit.
What is Opportunity Cost?
Microeconomic theory tells us that the opportunity costs of a particular activity are the loss of value or profit that would be incurred by engaging in that activity. It is the potential benefit when an investor, individual, and business owner misses out when choosing one alternative over another. 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 from an option that would have been a foregone benefit.
For evaluating opportunity costs options of every benefit are available must be considered and weighed against the others. Opportunity costs can also guide individuals and organizations to make better decisions. For calculation opportunity costs there is a formula i.e. Opportunity Cost = FO – CO here FO means the return on best-forgone option and CO means return on the chosen option. In this formula simply we 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 it comes to evaluating a company’s capital structure, the analysis of opportunity costs is crucial. Some individuals confuse sunk costs with opportunity costs, although they are not the same thing.
Main Differences Between Economic Profit And Opportunity Costs
- 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.
- The disadvantages of economic profit were that it is difficult to estimate whereas opportunity costs take too much time for calculation and there is also a lack of accounting.
- Economic profit shows the difference between revenue obtained whereas opportunity costs show us the potential benefits.
- Economic profit is used for internal analysis whereas opportunity costs are used for deeper analysis.
- 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 option which was chosen.
Conclusion
Economic profit and opportunity costs are not different from each other but both the terms are also not correlated with each other in terms of expenditure and all. Economic profit includes opportunities costs but opportunity costs have another concept in that formula of economic profit. Both terms are very helpful for making a big financial decision but it is also necessary to understand first their pros and cons which we already discussed.
It is up to the person, investor, and business owner how they would want to use their money and save for spending it and make use of these two terms in their business or anywhere else. Companies choose economic profit which involves production levels and business alternatives. Economic profit(or loss) is considered as a proxy for foregone profit. The calculation formula of economic profit is equal to revenues minus explicit costs minus opportunity costs.
References
- https://www.bostonfed.org/-/media/Documents/neer/neer498c.pdf