Question

Suppose an assistant professor of economics is earning a salary of $65,000 per year. One day she quits her​ job, withdraws ​$115,000

from a bank certificate of deposit​ (CD) that had been earning 5 percent per​ year, and uses the funds to open a bookstore. At the end of the​ year, she shows an accounting profit of

​$90,000 on her income tax return.

What is her economic​ profit? (rounded to the nearest dollar)

Answer 1

Economic profit = Accounting profit - implicit costs

Implicit costs are opportunity cost of doing a business. When the assistant professor opens a bookstore, she gives up a salary of $65,000 per year. Also in 1 year, the $115,000 she withdrew could have earned $(115,000*5%) = $5750 in interest. Therefore, the opportunity cost = $(65,000 + 5750) = $70,750

Therefore, Economic profit = $(90,000 - 70,750) = $19,250