Question

Arissa was earning $150,000 a year working as a pharmacist for a drug company. She decided to start her own business that conducted drug trials. She estimates this entrepreneurial talent or forgone entrepreneurial income to be $20,000 a year. She used $250,000 in savings that earned 10 percent interest annually to finance the new business. In the first year, the firm earned revenue of $1,000,000. The costs for rent, supplies, and employees’ salaries were $800,000 Calculate:(Show workings) i) Explicit cost, ii) Implicit cost, iii) Economic cost, iv) Accounting profit, v) Economic profit

Answer 1

i) Explicit cost

Explicit costs are cost within business such as salaries, cost of materials and rent

=$800,000 (presented as whole in the question; no calculation needed)

ii) Implicit cost

These are forgone cost that a business incur for choosing an alternative.

Entrepreneurial income = $20,000

Interest income = 10% of $250,000 (She uses saving to start the business)

=(10/100) X 250,000

= $25,000

Total implicit cost = $(20,000+25,000)

= $45,000

iii) Economic cost

Economic cost= Explicit costs-implicit costs

= $(800,000-45,000)

=$755,000

iv) Accounting Profit

These are earnings that accrue to a business from a chosen alternative.

=Total revenues - explicit costs

=$(1,000,000 - 800,000)

=$200,000

v) Economic profit

=Accounting profit-implicit costs

or

= Revenues-explicit cost-implicit cost

Revenues = $1,000,000

Explicit costs = $800,000

Implicit cost= $45,000

Economic profits= $(1,000,000-800,000-45,000)

=$255,000