Question

Frederick opened a small organic grocery store last year and is considering the profits he made. His store took in $120,000 in total revenue. To rent his storefront for the year, he had to invest $40,000. To supply it with the shelves, refrigerators, registers, and other miscellaneous equipment necessary, he had to invest another $10,000. Over the course of the year, he paid his employees a total of $35,000. To run his new business, he had to give up his old yearly salary of $30,000. Instead of investing his money in the business, he could have invested it in the stock market and earned 10% interest. Assume that the stock market is Frederick’s next best alternative for investing his money and that he did not pay himself a wage.

What were Frederick’s implicit costs?

What was Frederick’s accounting profit?

If Frederick’s goal was to make as much profit as possible, how does opening the grocery store compare with his next best alternative? (Hint: think about Frederick's economic profit)

Answer 1

Implicit Cost: The implicit cost of a firm is the cost of foregoing the next best alternative to opening a business. This is the opportunity cost of the firm's operation. In this case, the entrepreneur foregoes his yearly salary and the interest he could have earned in one year on the invested money. This two are the implicit cost of this firm. Therefore, the total implicit cost is

Accounting profit: Accounting profit is the difference between the total revenue of the firm and its total explicit cost. The explicit cost of the firm is a total investment in storefront and equipment and the salary paid to the worker. Then the explicit cost is

In this case, the earning from the business is equal to the implicit cost of the firm. This implies the economic profit (accounting profit minus implicit cost ) of the firm is zero. Therefore, opening the grocery store is profitable as its next best alternative.