Question

Q11. Economan has been infected by the free enterprise bug. He invests in some equipment to do research and publish results. He sets up and runs a firm that studies extraterrestrial genetic studies. For a one-year period the rent of the building is $10,000, the cost of two secretaries is $100,000 total, and the cost of utilities comes to $20,000. There is demand for the services and the revenues total $230,000 for the year. In order to run the business Economan gave up a chance to earn $110,000 in a job at the local Space Agency. In addition, he estimates that instead of investing in his business he could have put money in the bank and earned $5,000 interest.  

A) What is Economan’s accounting profit?

B) What can you say about his profit in an economic perspective? (Meaning did he make an economic profit? Please explain.)

C) Considering only the one year, was starting the business the best economic decision for Economan? (Please explain if he could have made more in an economic sense by using his time and resources in another way?)

Answer 1

a) Ecoman’s accounting profit =

= Total revenue - Total costs

= $230000 - ($10000 + $100000 + $20000)

= $230000 - $130000

= $100000.

b) Economic profit is the profit when the opportunity cost are also included. The opportunity cost of running the business would be the salary he could have earned and the interest that could be earned by depositing the money.

Opportunity cost = 110000 + 5000 = $115000.

So, the economic profit =

= Accounting profit - Opportunity cost

= $100000 - $115000

= -$15000.

c) If we consider only the first year, then we need to calculate the economic profit from both the alternatives.

From doing business, the economic profit will be -$15000

If job is taken up, the accounting profit =

= 110000 + 5000

= $115000.

The opportunity cost of doing the job will be equal to the accounting profit from the business.

Opportunity cost of business = $100000

So, economic profit of doing job =

Accounting profit from doing job - Opportunity cost of doing job

= $115000 - $100000

= $15000.

So, we can see that starting the business would not be the best decision and it would be more profitable to use his time and resource in doing the job.

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