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Economic profit is the difference between the revenue a firm earns from sales and the firm’s total opportunity costs.

It’s important to distinguish between accounting profit and economic profit. Accounting profit is total revenue minus the explicit costs of producing goods or services. Explicit costs are things like raw materials and employee wages. This is what most people are referring to when they talk about profit.

Economic profit includes the opportunity costs a company loses or gains by making a decision to pursue one avenue towards revenue, thus passing by a different opportunity which also might have produced revenue. A firm can have a large accounting profit, but no economic profit.

For example, an investor starts her own business with $100,000 and earns $120,000 in profits during the first year. Her accounting profit is $20,000. But that same year, she could have earned an income of $45,000 working as an employee for ABC Corporation. The investor’s economic profit for the year is actually a loss of $25,000.

Economic profit often determines whether a firm should enter or exit a market. It’s used to calculate total production costs and to assess a company’s total value.

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