Question

Waterworks Irrigation was a startup that was open for only one year of operation. During that year, it collected $175,000 in revenue and spent $50,000 on trucks, irrigation supplies, employees, and utilities. The owner of the firm, Cosmo, spent $100,000 of his own money to buy an office building and set up the office (instead of buying bonds and earning a 10% annual rate of return), which he later sold at the end of the year for $100,000. The firm's economic profit is:

Answer 1

The economic profit of Waterworks Irrigation  is $115,000.

Economic profit is revenue less explicit cost and opportunity cost.

Explicit cost is the cost incurred in the course of running the start-up. It includes administrative cost, rent and cost of raw materials.

Opportunity cost or implicit cost is the cost of the next best option that a decision maker forgoes when he chooses one option over other options.

Economic profit = revenue - explicit cost - opportunity cost

• Revenue = $175,000

• Explicit cost = $50,000

• Opportunity cost = 10% x 100,000 = $10,000

$175,000 - $50,000 - $10,000 = $115,000

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