Question

Thomas sets up a new coffee shop in a building he owns. He puts $200,000 of his money into the business. He could have got 8% interest on this money if he had deposited it in an investment account. He gives up his job, which paid him $50,000 a year. He could rent the building out for $10,000 a year.

His business incurs explicit costs of $80,000 (excluding any salary for himself).

Based on the information above, choose the correct answer for each of the following questions.

What is his economic profit if revenues are $180,000?
His revenues are $80,000 in year 1. What is his economic profit?

Answer 1

Answer : Calculation of Implicit cost:

Interest foregone on investment amount = $2,00,000×0.08 = $16000

Salary received by Mr Thomas = $50,000

Rent of the Building = $10,000

Total Implicit Cost = $76000

Explicit cost =$80,000

A. When revenue earned = $180000

Economic profit = Revenue - (Explicit cost+Implicit cost)

Economic profit = $180000-(80000+76000) = $24000

B . When revenue is $80,000

Economic profit = Revenue - ( Explicit+ Implicit)

Economic profit = $80000-(80000+76000)

Economic profit = -$76000

Now Mr Thomas earns a loss of $76000.