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 he could use his talents to earn an additional $5,000 per year in consulting fees if he were working full time as a potter. Total annual revenue from pottery sales is $82,000. Calculate the accounting profit and the economic profit for Gomez’s pottery firm.

Answer 1

Answer:

Gomez

The accounting profit = $40,500

The economic profit = $9,000

Explanation:

a) Data and Calculations:

Accounting Profit    

Annual revenue              $82,000

Expenses:

Wages              $15,000

Rent                     6,500

Materials           23,000   44,500

Net income                    $40,500

Economic Profit

Net income                                             $40,500

Opportunity cost:

Return on investment              $6,000

Salaries                                     20,500

Additional consulting fees         5,000

Total opportunity cost                           $31,500

Economic profit                                      $9,000

b) What differentiates Gomez accounting profit and economic profit is that its accounting profit only records the financial inflows and outflows while its economic profit considers the opportunity cost of alternative investments.