Question

1. Dane decides to give up a job earning $200,000 per year as a corporate lawyer and converts a duplex he owns into a UFO museum. The market rent for a similar duplex is $20,000 a year. He pays wages of $75,000 a year to his assistants and $10,000 a year for utilities. Fans flock to the museum to see his collection of extraterrestrial paraphernalia. Over the course of the year, the museum brings in revenues of $200,000.

Use the information above to answer the following questions. [Hint: ignore that value of Dane’s extraterrestrial paraphernalia]

a. Calculate Dane’s accounting profits[5points]

b. Calculate Dane’s economic profits[5points]

c. Based on the performance of the museum in this one year, should Dane have quit his job as a corporate lawyer? Briefly explain why or why not. [5 points]

Answer 1

ans......
(A). Accounting profit is calculated by subtracting the net revenue from net costs. It indicates the profitability a firm has earned over a course of an year. Here, Dane earns $200,000 through the museum he set, and bears costs of $75,000 paid to his assistants and $10,000 for utilities, total amounting to $85,000.
His accounting profit is thus AP = 200,000 -85,000
Which turns out to be $115,000. Dane's accounting profit is thus $ 115,000
(B). Economic profit is a bit different than accounting profit. The latter terms gives only an indication of the net revenue earned in a period while economic profit indicates how successful the firm is over a period of time. Economic profit thus takes into account opportunity costs as well because the manager has to consider how successful his firm might have been if various alternatives are considered. Hence, economic profit is a better measure for the long run.
Here Dane had some choices or alternatives that need to be stressed upon.
1. He could have continued his career has a lawyer, earning $200,000 each year with $20,000 as an extra earning through renting out his duplex. He was thus earning $220,000 each year.
2. Dane voluntarily retired as a lawyer and took into converting his duplex into a UFO museum. Here, he earns $200,000 each year, $20,000 less than the first alternative
(C). Let us now observe his opportunity costs and the relation they have to his total revenue.
In the first alternative, Dane earns $220,000 each year. In the second alternative, he earns only $200,000 each year. Add to it the costs incurred, the real amount is $115,000.
Now, economic profit measures how successful the firm has been in the long run.
where it would be more preferable for him to opt for the first alternative, taking into consideration the opportunity costs he will incur if he were to give up his job. Opting for the first alternative will provide him with a constant income of $220,000 each year.