Economic profit is calculated by

Question

BlackTom AI · Accepted Answer

Economic profit equals total revenue minus explicit and implicit costs, so it measures true economic return after accounting for opportunity costs.

Relevant knowledge points:
- Total revenue (TR) is the money a firm receives from sales.
- Explicit costs are out-of-pocket payments (wages, rent, materials).
- Implicit costs are opportunity costs of resources owned by the firm (foregone salary, foregone interest on invested capital).
- Accounting profit = TR − explicit costs. Economic profit = TR − (explicit + implicit costs).

Step-by-step reasoning and example:
1. Start with total revenue: TR.
2. Identify explicit costs (E) and implicit costs (I).
3. Subtract both kinds of costs from revenue: Economic profit = TR − E − I = TR − (E + I).
4. Example: TR = $100, explicit costs = $60, implicit costs = $20.
   - Compute TR − E = $100 − $60 = $40 (this is accounting profit).
   - Compute economic profit: TR − (E + I) = $100 − ($60 + $20) = $100 − $80 = $20.
   - Note: economic profit ($20) is less than accounting profit ($40) because it includes opportunity costs.

Why the correct answer is correct:
- Economic profit explicitly includes both explicit and implicit costs; failing to subtract implicit costs would overstate a firm’s profitability in economic terms.

Why other options are incorrect:
- a. deducting explicit costs from revenue: describes accounting profit, not economic profit.
- b. deducting implicit costs from revenue: ignores explicit, so incomplete.
- c. deducting revenue from costs: reverses the formula and yields a sign-inverted value, not the definition of profit.

Conclusion: The correct choice is d — deducting explicit and implicit costs from revenue, which matches the provided answer.

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