Question

Mary gives up her job earning $150,000/ year as a Digital Overlord and converts a house that she owns into a museum for her extensive collection of salt and pepper shakers. Prior to this idea, Mary had been renting the house out for $20,000/year. Mary hired 2 employees for her museum at a total cost of $50,000/yr, and had to pay $10,000/yr for utilities.

Surprisingly, her museum was a huge hit and brought in revenues of $125,000 the first year. One salt and pepper shaker fan even offered her $1,000,000 to purchase her entire collection, which she politely declined, since salt and pepper shakers are pricelss.

1) What is Mary's accounting profit during the year?
2. What is Mary's economic profit? Explain.

Answer 1

Answer (a): Accounting profits = 1,25,000- 50,000- 10,000 = $65,000 per year.

Answer (b): Economic profits = Accounting profits - Opportunity costs

Opportunity cost is the cost of the next best alternative foregone.

In the given case, if Mary wouldn't have converted her house into a museum, she would have rented it for $20,000 per year and also would have continued the job for $1,50,000 per year. Total benefits foregone = $1,70,000.

It is also given that she recieved an offer to purchase the museum at $10,00,000 which she declined. This is not an opportunity cost as it is a benefit which can be attained after the museum has already been set. So, in calculation of economic profits, it is ignored.

therfore, economic profits = 65,000- 1,70,000 = -$1,05,000.
economic loss = $1,05,000.