Answer to Question #139299 in Macroeconomics for rishab

Question

1. Andrew operates a small shop specializing in party favors. He owns the building and supplies all his own labor and money capital. Thus, Andrew incurs no explicit rental or wage costs. Before starting his own business Andrew earned $1,000 per month by renting out the store and earned $2,500 per month as a store manager for a large department store chain. Because Andrew uses his own money capital, he also sacrificed $1,000 per month in interest earned on U.S. Treasury bonds. Andrew's monthly revenues from operating his shop are $10,000 and his total monthly expenses for labor and supplies amounted to $6,000. Calculate Andrew’s monthly accounting and economic profits.

Answer 1

Total accounting profit is calculated as follows:

Total revenue $10,000

Total explicit costs 6,000

Accounting profit $4,000

Andrew’s accounting profit appears to be a healthy $4,000 per month.

If we take into account Andrew's hidden costs, we get a different result.

Total economic profit is calculated as follows:

Total revenue $10,000

Total explicit costs 6,000

Forgone rent 1,000

Forgone salary 2,500

Forgone interest income 1,000

Total implicit costs 4,500

Total economic costs 10,500

Economic profit (loss) $ (500)

Economic profits are equal to total revenue less total economic costs, which is the sum of explicit and implicit costs.

Accounting profits, on the other hand, are equal to total revenue less total explicit costs.