Question

Suppose that you open your own business and earn an accounting profit of​ $35,000 per year. When you started your​ business, you left a job that paid you a​ $30,000 salary annually.​ Also, suppose that you invested​ $70,000 of your own funds to start up your business. If the normal rate of return on capital is 10​ percent, your economic profit is

A.

​$5,000.

B.

−​$5,000.

C.

−​$2,000.

D.

​$2,000.

Answer 1

Given accounting profit is 35,000

For the calculation of economic profit, we have to calculate the implicit costs. Implicit cost includes benefit of own investment and benefit of own services. In this question, the implicit costs are

Salary from the job left on starting of own business is 30,000.

Rate of return on own funds is 10% of 70,000 is 7,000

Total implicit cost is 30,000+7,000=37,000

Economic Profit = Accounting Profit - Implicit Cost

Economic Profit = 35,000 - 37,000 = -2,000 (Economic Loss)

Answer - (C) -2,000