Question

A business graduate worked several years at a Lebanese bank for an annual salary of $12,000. After saving $20,000, she decided to open a consulting office for financial advice and services (as a side business). She used her savings to buy $ 8,000 worth of computer equipment, desks and chairs. She also hired a secretary to handle customers during the day for an annual salary of $9,000, rented an office for $10,000 per year, and spent on average $300 in other running costs each month. During the first year, her business generated revenues of $35,000. Prior to the investment, her $20,000 were in a long-term saving account at the bank earning an annual interest of 10%. a) Did she make accounting profits in the first year? b) Did she make economic profits? c) How would the answer to the last question have differed if she had decided to quit her bank job to manage her new business (without a secretary)? [Provide full explanations to all answers.]

Answer 1

1) Yes, the firm made economic profits of $4,400

Working

Revenue		35,000
Explicit cost
Computer	8,000
Secretary salary	9,000
Rent	10,000
Running costs 300*12 months	3,600	30,600
Accounting profit/loss		4,400

　

2) Yes, the firm made accounting profits of $2,400

Working

Revenue		35,000
Explicit cost
Computer	8,000
Secretary salary	9,000
Rent	10,000
Running costs 300*12 months	3,600	30,600
Accounting profit/loss		4,400
Implicit Cost
Interest on capital (20,000*10%)	2000	2,000
Economic profit/loss		2,400

　

3) If had decided to quit her bank job to manage her new business then would have not earned economic profits:

　

Working:

Revenue		35,000
Explicit cost
Computer	8,000
Secretary salary	9,000
Rent	10,000
Running costs 300*12 months	3,600	30,600
Accounting profit/loss		4,400
Implicit Cost
annual salary	12,000
Interest on capital (20,000*10%)	2000	14,000
Economic profit/loss		-9,600