Question

Opportunity cost

Sarah quit her job as a nurse where she was earning $50,000 per year to start a business (salon). To begin the business, Sarah withdraws $80,000 from the bank from which she was earning 5% interest rate. Also, to begin the business Sarah resigns her sports career where she was earning $30,000 per year.

You are given the following information regarding the performance of the salon for the 1st year

Total revenue $ 200,000

Cost of labour $ 80,000

Cost of inputs $ 30,000

Other cost $ 20,000

Task   

Calculate Sarah’s economic cost and accounting cost.

Calculate Sarah’s economic profit and accounting profit.

Do you think Sarah made the right decision to quit her nursing job and sports career? Explain based on your calculations.

Answer 1

i)

Implicit cost includes the opportunity costs.

Implicit Cost=Income that he has foregone=50000+30000+80000*5%=$84000

Explicit Cost includes the direct accounting costs

Explicit Cost=Cost of labor+Cost of inputs+Other Cost=80000+30000+20000=$130000

Total Cost=Implicit Cost+Explicit Cost=130000+84000=$214,000

ii)

Accounting Cost=Total Revenue-Explicit Cost=200000-130000=$70000

Economic Cost=Total Revenue-Total Cost=200000-214000=-$14000

iii)

We observe that economic profit is negative, It means that Sarah did not make the right decision to quit her nursing job and sports career.