Question

You are considering opening a small flower store. You anticipate that you will earn $100k each year in revenue. It will cost you $30k each year to rent the space necessary to run your business. Additionally, you will need to spend $10k each year on flower seeds, utilities, and other expenses necessary to operate your flower shop. You have just graduated from college with a degree in economics and have received an offer to work for a firm with an annual salary of $70k. Should you open your flower shop?

No, because your accounting profit is negative.

No, because your economic profit is negative.

Yes, because your accounting profit is positive.

Yes, because your economic profit is positive.

Answer 1

In order to decide whether to open a shop or not we have to calculate economic profit and if economic profit comes out to be negative then we will not open the store and if it comes out positive we will open the store.Economic profit = Revenue - explicit cost - implicit cost.

Explicit cost is the cost it directly incurs in order to run the business and that cost is Rent of a space + Cost of buying flowers, utilities, etc => Explicit cost = 30K + 10K = 40K.

Implicit cost is the income that he sacrificed in order to open a store and here than income is annual salary that he could earn if he didn't open a store and thus Implicit Cost = 70K

It is given that Revenue = 100K

Hence, Economic profit = Revenue - explicit cost - implicit cost = 100K - 40K - 70K = -10K which is negative.

Since, economic profit is negative, he should not open a store.

{Note that Accounting profit = Revenue - explicit cost = 100K - 40K = 60K which is positive. But we do not use it to make decision whether to open a shop or not}

Hence, the correct answer is (b) No, because your economic profit is negative.