Question

Suppose your current job pays you $125,000 a year. However, you are considering starting your own company. Based upon your research, you estimate your first year total revenue to be $3,000,000. There are however several costs of running the company during this first year, such as the cost of materials which will equal $1,200,000, employees who will receive in total $850,000, utilities which will cost $350,000, and rent that will be paid to the landlord that equals $500,000. Based on this information, solve for both your accounting profit and economic profit during this first year. Also, state whether you are better off starting this company or staying in your current job.

Answer 1

Accounting profit is total revenue minus explicit costs.

Total revenue= $3,000,000.

Explicit costs

E.xplicit cost that require monetary payment.

Explicit costs are:

Materials = $1,200,000,

Payment to employees = $850,000,

Utilities=  $350,000

Rent = $500,000.

Total explicit costs are: $1,200,000 +  $850,000 + $350,000 + $500,000.= $2,900,000.

Accounting profit= $3,000,000 -2,900,000=$100,000.

Implicit or opportunity costs do not require actual monetary payments. Implicit costs are opportunity costs. Opportunity cost is the value of the next best alternative.

Economic profit= Accounting profit-implicit costs.

Implicit cost is the salary foregone= $125,000

Economic profit= $100,000 - $125,000 = -$25,000 (loss).

Economic profit is negative, so it is advisable not to start the company,