Question

1. You and your best friend are brilliant entrepreneurs who are considering opening your own business tutoring struggling college students in economics. This wonderful endeavor takes the place of the job you were offered working for a rival tutoring service and earning $2,500 a month. Your best friend was offered a similar job at $2,000 (better not tell him about your offer!). Operating expenses for your tutoring business will total $4,000 monthly when you include variable costs such as hiring other tutors. Additionally you will need to lease a building to work out of for $2,000 per month. Together the two of you have enough to cover these operating expenses and the lease but if you pull that money out of your bank accounts you will lose out on $500 in interest income you could have collectively earned. You anticipate revenue from your tutoring business will be $10,000 per month. a. What would be the accounting profit/loss for your business? What about the economic profit/loss? b. Should you and your friend open the business? Why or why not?

Answer 1

Answer:

a. Accounting profit for the business = $3,500

b. Economic loss = $1,000

c. The two friends can open the business and incur economic loss of $1,000 in the first year of operation.  In subsequent years, the revenue may increase to generate better economic profit.  This is the labor, risk, and reward of entrepreneurship.

d. If the two friends do not go ahead with the business because of the economic loss they suffer in the first year of operation, then they cannot be regarded as entrepreneurs.  They are merely laborers who cannot assume any risk for greater rewards tomorrow.

Explanation:

Cost of business per month:

Operating expenses = $4,000

Lease of building =        2,000

Total expenses =        $6,000

Revenue =                 $10,000

Accounting profit       $4,000

Economic profit:

Revenue =               $10,000

Total expenses =     $6,000

Opportunity costs:

Lost salaries              4,500

Lost Interest                500

Total costs             $11,000

Economic loss =     $1,000