Question

Question - Adam is the owner of a small grocery store in a busy section of Boulder, Colorado. Adam’s annual revenue is $200,000 and his total explicit cost (Adam pays himself an annual salary of $30,000) is $180,000 per year. A supermarket chain wants to hire Adam as its general manager for $60,000 per year.

a. What is the opportunity cost to Adam of owning and managing the grocery store ?
b. What is Adam’s accounting profit ?
c. What is Adam’s economic profit ?

Answer 1

a) $\bold {Answer}$

Opportunity cost = $\$60,000$ per year

$\bold {Solution}$

Opportunity cost is defined as the forgone befit of the next best alternative forgone when a choice is made. In owning and managing the grocery store, Adam will forgo the $60,000 salary he would have earned by being a supermarket manager. Thus, his opportunity cost = supermarket salary forgone = $60,000 per year.

b) $\bold {Answer}$

Accounting profits $= \$20,000$ per year.

$\bold {Solution}$

Accounting profits

= Total revenue - Total explicit costs

$= \$200,000-\$180,000$

$=\$20,000$ per year

c) $\bold {Answer}$

Economic profits $= -\$40,000$ per year

$\bold {Solution}$

Economic profits

= Total revenue - Total cost

= Total revenue - (Explicit costs + Implicit costs)

= (Total revenue - Explicit costs) - Implicit cost

= Accounting profit - Opportunity cost

$=$ $\$20,000-\$60,000$

$= -\$40,000$ per year