Question

Suppose an engineer leaves her $100,000 per year job to start a consulting business. Assume she borrows all of the money needed to start the business. In the first-year revenue is $500,000, the salaries paid to employees total $300,000 and the interest paid on the loan is $50,000. The economic profit of the firm is, therefore, $150,000.

Is this true, false, or uncertain? If so please explain in detail why.

Answer 1

False

Explanation:

Economic profit considers both the explicit and implicit costs.

Here, total explicit costs = salaries + interest = $300,000 + $50,000 = $350,000.

Implicit costs = salary given up = $100,000

So, economic profit = revenue - (explicit costs + implicit costs) = $500,000 - ($350,000 + $100,000) = $500,000 - $450,000 = $50,000.