Question

2. Debbie was earning $100,000 a year working as a scientist for a drug company. She decided to start her own business that conducted drug trials. She estimates this entrepreneurial talent or forgone entrepreneurial income to be $10,000 a year. She used $500,000 in savings that earned 5 percent interest annually to finance the new business. In the first year, the firm earned revenue of $1,500,000. The costs for rent, supplies, and employees’ salaries were $1,100,000. What was the accounting profit for the new business? What was the economic profit (or loss)? Explain your calculations for both questions.

Answer 1

Total revenue = $1,500,000

Explicit costs (rent, supplies, and employee salaries and benefits) were $1,100,000.

Accounting profit = Total revenue - Explicit costs

Accounting profit = $1,500,000 - $1,100,000

Accounting profit = $400,000

Implicit costs = $135,000 ($25,000 in forgone interest on the $500,000 plus forgone salary of $100,000 plus forgone entrepreneurial income of $10,000).

Economic profit = Total revenue - Explicit costs - Implicit costs

Economic profit = $1,500,000 - $1,100,000 - $135,000

Economic profit = $265,000‬

The firm had an economic profit of $265,000‬