Question

Gomez runs a small pottery firm. He hires one helper at $15,000 per year, pays annual rent of $6,500 for his shop, and spends $23,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $6,000 per year if alternatively invested. He has been offered $20,500 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $5,000 per year (input cost for organizing resources). Total annual revenue from pottery sales is $82,000. Calculate the accounting profit and the economic profit for Gomez’s pottery firm. Accounting profit = $ Economic profit = $

Answer 1

Answer

Gomez's business accounting profit amounted to $37500 while economic profit is $6000

Accounting profit is simply deducting explicit costs from revenue.Explicit costs are costs that require actual cash flow from the entity.

Economic profit on the other hand is calculated by deducting both explicit and implicit costs from revenue.

Implicit costs are costs relating to alternative opportunities forgone.

Explanation:

Both accounting and economic profits are highlighted below:

Accounting profit=Total revenue-explicit costs  

Revenue                 $82,000  

Helper's wages  ($15,000)

Rent                   ($6,500)

Materials                   ($23,000)

Accounting profit     $37,500  

 

Economic profit =Revenue -explicit costs-implicit costs  

Revenue                               $82,000  

Helper's wages                ($15,000)

Rent                                 ($6,500)

Materials                                 ($23,000)

Return lost money invested  ($6,000)

Lost income from porter's offer     ($20,500)

Entrepreneur's talent             ($5,000)

Economic profit =                       $6,000