Question

Dolores used to work as a high school teacher for $40,000 per year but quit in order to start her own catering business. To invest in her factory, she withdrew $20,000 fromher savings, which paid 5 percent interest, and borrowed $30,000 from her uncle, whom she pays 4 percent interest per year. Last year she paid $25,000 for ingredients and had revenue of $60,000. She asked Louis the accountant and Greg the economist to calculate her profit for her.

Explicit cost- ?

Implicit cost-?

Accounting profit-?

Economic profit-?

Answer 1

(a)

Following are the explicit cost of Dolores -

1. Cost of ingredients = $25,000

2. Interest paid on loan from Uncle = $30,000 * 0.04 = $1,200

Total explicit cost = $25,000 + $1,200 = $26,200

Thus,

Total explicit cost of Dolores is $26,200.

(b)

Following are the implicit cost of Dolores -

1. Foregone salary = $40,000

2. Foregone interest = $20,000 * 0.05 = $1,000

Total implicit cost = $40,000 + $1,000 = $41,000

Thus,

Total implicit cost of Dolores is $41,000.

(c)

Calculate the accounting profit -

Accounting profit = Total revenue - Total explicit cost = $60,000 - $26,200 = $33,800

The accounting profit of Dolores is $33,800.

(d)

Calculate the economic profit -

Economic profit = Total revenue - Total explicit cost - Total implicit cost

Economic profit = $60,000 - $26,200 - $41,000 = -$7,200

The economic profit of Dolores is -$7,200.

This means Dolores is incurring an economic loss of $7,200.