Question

Assuming that you currently work for a consulting firm. You are considering opening your own consulting firm, where you expect to earn RM 200,000 per year once you get established. To run his own firm, you would need an office and a law clerk. You have found the perfect office, which rents for RM 50,000 per year. A law clerk could be hired for RM 35,000 per year. To open your own consulting firm, you would have to quit his current job, where he is earning an annual salary of RM125,000.

1. What are your accounting costs?
2. What are your opportunity costs?
3. Would your consulting firm be profitable?
4. How much would you need to make in revenues to earn Positive economic profits?

Answer 1

i) Accounting costs are explicit costs or out of pocket cost of doing a business. If you're considering opening your own consulting firm, the explicit costs you'll incur are hiring a law clerk and paying rent for the office.

Therefore, accounting costs = RM 50,000 + RM 35,000 = RM 85,000

ii) Opportunity cost of doing a business is what you have to give up in order to do that business. If you're considering opening your own consulting firm, you have to give up your current job.

Therefore, opportunity cost = RM 125,000

iii) Once you get established, you'll earn a total revenue of RM 200,000 per year. The total cost of doing your business = RM 85,000 + RM 125,000 = RM 210,000.

As Total cost exceeds total revenue, you'll make loss. Therefore, this consulting firm won't be profitable.

iv) Economic profit = Total Revenue - Total cost

Where, Total cost = Accounting costs + opportunity cost

Therefore, in order to make positive economic profit, you'll have to make more than RM 210,000 in revenue per year.