Question

Last year, Jarod left a job that pays $60,000 to run his own bike-repair shop. Jarod’s shop charges $75 for a repair, and last year the shop performed 3,000 repairs. Jarod’s production costs for the year included rent, wages, and equipment. Jarod spent $50,000 on rent and $120,000 on wages for his employees. Jarod keeps whatever profit the shop earns, but does not pay himself an official wage. Jarod borrowed $20,000 for the shop’s equipment at an annual interest rate of 5 percent.

Round to the nearest dollar.

a. What is Jarod’s accounting profit?

    $.

b. What is Jarod’s economic profit?

    $.

Answer 1

A.

Accounting profit considers only the explicit costs. Here, total explicit cost = rent + wages + interest paid = $50,000 + $120,000 + 5% of $20,000 = $50,000 + $120,000 + 5/100 * $20,000 = $170,000 + $1,000 = $171,000.

Total revenue = $75 * 3,000 = $225,000

So, accounting profit = revenue - explicit costs = $225,000 - $171,000 = $54,000.

B.

Economic profit considers both explicit and implicit costs. Here, implicit costs = $60,000 salary foregone in the previous job.

Economic profit = Accounting profit - implicit costs =  $54,000 - $60,000 = -$6,000.