Question

A few years ago, a Professor earning $40,000 at a college quit his job and decided to open his own painting company. He took $50,000 out of his retirement account earning 10% per year. When computing his accounting profit he expensed his one employee for $25,000 and his material costs of $100,000. Suppose he generated $200,000 in sales. Calculate the accounting profit and economic profit for the business.

a. 75,000; 30,000

b. 75,000; 35,000

c. 75,000; -15,000

d. 70,000; $35,000

e. None of the above

Answer 1

Ans) Explicit costs are the direct payments made. While Implicit cost are basically the opportunity cost.

Accounting profit takes into account only the explicit cost while economic profit takes into account both implicit and explicit cost.

Accounting profit = total revenue - explicit cost

Economic profit = total revenue - (implicit + explicit cost)

Now,

Explicit cost = wage of the worker + material costs

Explicit cost = $25,000 + $100,000 = $125,000

Implicit costs = salary of previous job + interest earned on savings

Implicit costs = $40,000 + 10% of $50,000

Implicit cost = $40,000 + $5,000 = $45,000

Accounting profit = $200,000 - $125,000 = $75,000

Economic profit = $200,00 - ($125,000 + $45,000) = $30,000

Option a.