Question

Susan quit her job as a teacher, which paid her $36,000 per year in order to start her own catering business. She spent $12,000 of her savings, which had been earning 10% interest per year, on equipment for her business. She also borrowed $12,000 from her bank at 10% interest, which she also spent on equipment. For the past several months she has spent $1,000 per month on ingredients and other variables costs. Also for the past several months she has taken in $3500 in monthly revenue. Should Susan continue operating in the short-run and long-run?

Answer 1

Answer:

In the short run Susan can continue operating because her business is making an accounting profit, but unless her revenues increase, she should not continue operating in the long run. In the long run, economic profit/loss = $0, and Susan is not even close. She should keep working in her catering business until she can return to her old teaching job (or get a new one).

Explanation:

Susan's accounting profit/loss = total revenue - total expenses = ($3,500 x 12) - [($1,000 x 12) + ($12,000 x 10%)] = $42,000 - $13,200 = $28,800

Susan's economic profit/loss = accounting profit - opportunity costs

opportunity costs are the extra costs or benefits lost from choosing one activity or investment over another alternative. In this case, Susan's opportunity cost = $36,000 in lost salaries + $1,200 in lost interests = $37,200

Susan's economic loss = $28,800 - $37,200 = $8,400

In the short run Susan can continue operating because her business is making an accounting profit, but unless her revenues increase, she should not continue operating in the long run. In the long run, economic profit/loss = $0, and Susan is not even close. She should keep working in her catering business until she can return to her old teaching job (or get a new one).