Question

You are currently working as a Senior Economist for the Congressional Budget Office in Washington DC making $108,000 per year. Your lifelong ambition, however, has been to open your own cupcake store. You decide to quit your job as an economist to open your dream store near the River Walk in San Antonio. You estimate that you will be able to sell 10,000 cupcakes per month at a price of $3.40 per cupcake. You will have to pay monthly rent of $5,000 for renting the retail space and will have other cash costs of $2,500 per month (utilities etc.). The ingredients will cost you $2.00 per cupcake.

1. (3 points) Calculate monthly accounting profits

2. (3 points) Calculate monthly economic profits

3. (3 points) Would an economist recommend that you start this business? Why or Why not?

Answer 1

✓ Accounting profit is calculated by total revenue minus total explicit.

Here total revenue earned by selling 10,000 cupcakes per month is 10,000*$3.40 = $34,000.

Total explicit cost is = Rent ($5,000/Month) + Other cash costs ($2,500/Month) + Ingredient cost ($2*10,000 = $20,000 per month)

Total explicit cost is = $5,000 + $2,500 + $20,000 = $27,500

Therefore, Monthly Accounting profit = $34,000 - $27,500 = $6,500. (Ans).

✓ Monthly Economic Profit = Total revenue - Explicit cost - Implicit costs

Monthly Economic Profit = $34,000 - $27,500 - $108,000/12

Monthly Economic Profit = $34,000 - $27,500 - $9,000

Monthly Economic Profit = - $1,500. (Ans).

Implicit costs are those costs which are not directly out of pocket cost but these costs are kind of opportunity cost i.e the opportunity of earning was there by using those inputs owned by the owner. It is the owner's own use of resources which could have used in another purpose which will give return.

Here implicit cost is salary of working as an Economist for the Congressional Budget Office. Yearly salary is $108,000. So Monthly salary is = $108,000/12 = $9,000.

✓ As an economist anybody will not recommend this business. Because the economic profit of this business is negative. Economic profit of this business is - $1,500. When there is negative economic profit from a business an economist never suggest to do that business.