Question

You start your own business on 1/1/2015. during the year 2015, your sales revenues are $200,000. you pay your assistant $50,000 and pay $20,000 for materials and utilities. you work in your own business, but in your next best alternative you could earn an annual labor income of $60,000. [you do not own any capital equipment or other resources. -- do not worry about depreciation or any costs associated with capital in this question.] your economic profit for 2015 is ________

Answer 1

Your economic profit for 2015 is $70,000.

Economic profits are calculated by using the formula:

Economic Profit = Sales - (Explicit Costs + Implicit Costs)

Explicit Costs are costs that are incurred in the normal course of a business like cost of materials, wages, rent etc. In this question, cost of materials and assistant's salary are the explicit costs.

Implicit Costs or opportunity costs refer to the returns an individual misses out on account of making a choice. In the given context, you chose to start a business; however, if you had chosen to remain employed elsewhere, you would have earned $60,000. So, this $60,000 is an implicit cost or an opportunity cost.

So, Economic Profit is calculated as:

Economic Profit = $200,000 - ($50,000+ $20,000 + $60,000)

Economic Profit = $70,000.