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

A.) ACCOUNTING COST
Accounting cost is the actual monetary cost a firm incurs. It is also called an explicit cost.
ACCOUNTING COST = RM 50,000 + RM 35,000 = RM 85,000
  

B.) OPPORTUNITY COST
Opportunity cost is the next best alternative. It is the benefits an individual misses out when he chooses one alternative over others.
It includes both implicit and explicit cost.
OPPORTUNITY COST = IMPLICIT COST + EXPLICIT COST
= RM 125,000 + RM 50,000 + RM 35,000 = RM 210,000

C.) ACCOUNTING PROFIT = TOTAL REVENUE – EXPLICIT COST
= RM 200,000 – RM 85,000
= RM 115,000
As in opening consulting firm, there is positive accounting profit so the firm is profitable. There are positive cash inflows versus outflows. But when we subtract the opportunity cost it is negative. It means working in a consulting firm is more profitable for me than opening a consulting firm.

D.) ECONOMIC PROFIT
ECONOMIC PROFIT = TOTAL REVENUE – EXPLICIT COST( accounting cost) – IMPLICIT COST( opportunity cost)
= RM 200,000 - RM 85,000 – RM 125,000
= - 10,000
I NEED TO MAKE MORE THAN RM 10,000 TO EARN POSITIVE ECONOMIC PROFIT.