Question

In economics, how is "economic profit" defined?

Answer 1

Economic profit (or loss) refers to the difference between the total revenue and the opportunity cost associated with the revenue generated. Opportunity cost is the cost of an opportunity foregone, i.e., given up in order to pursue another one.

For example, assume a company needs to make significant changes in their business model in order to survive in the market and beat the competition. After a review of their business model, the manager suggests that the company can survive if it adopts either of two feasible options: cost-cutting or the introduction of new product lines.

Management decides to go forward with cost-cutting. In such a case, the potential earnings that could be generated by introducing a new product are given up in exchange for the increased profits realized by cutting costs. Choosing not to pursue developing new product lines represents a lost opportunity. Hopefully, the company has done careful cost-benefit analysis and discovered that the largest potential profit increase will be derived from reducing operating costs.