Question

Accounting vs Economic Profit

You own and operate a bike store. Each year, you receive revenue of $200,000 from your bike sales, and it costs you $100,000 to obtain the bikes. In addition, you pay $20,000 for electricity, taxes, and other expenses per year. Instead of running the bike store, you could become an accountant and receive a yearly salary of $40,000. A large clothing retail chain wants to expand and offers to rent the store from you for $50,000 per year. How do you explain to your friends that despite making a profit, it is too costly for you to continue running your store?

(a) Find your accounting profit.

(b) Find your economic profit.

(c) Explain your decision.

Answer 1

Answer
The explicit cost=100000+20000=120000
implicit cost=salary +rent=40000+50000=$90000
a)
accounting profit=revenue -explicit cost
=200000-120000
=$80000
b)
The economic profit of running store =accounting profit-implicit cost
=80000-90000
=-$10000
c)
The economic profit shows the best higher return from the business but here the store is earning economic losses means to open store is not the best return on the investment whereas your friend can earn more $10000 if he works as the accountant and rent the store.
The best decision is not to open a store and do the job.