After graduation you decide to open your own business. In doing so you give up t

Question

After graduation you decide to open your own business. In doing so you give up the opportunity to work for a steady wage of $45,000 per year at a well established company. To start the business you use $20,000 out of your own savings account spending it all on the business. That $20,000 would have earned you $200 in interest. After a year of operations, you have the following information regarding additional costs and revenues.

Revenue = $100,000

Rent / Utilities = $12,000

Advertising = $2,000

Other operating costs = $10,000

a. How much are the explicit costs?

b. How much are the implicit costs?

c. How much is the Accounting Profit?

d. How much is the Economic Profit?

Explanation / Answer

A. Explicit cost is the out of pocket cost. It includes initial business starting cost,rent, advertising, operating costs.

Explicit cost= $(20000+12000+2000+10000)= $44,000

B. Implicit cost doesn't involve a cash payment. It's an opportunity cost. It includes the salary you forgo to start your own business and the interest you would have earned if you would have kept those $20000 in savings account rather than spending it on business.

Implicit cost= $(45000+200) =$45200

C. Accounting profit= Total revenue - explicit cost

= $(100,000 - 44,000) = $ 56,000

D. Economic profit= Accounting profit - implicit cost

= $ (56000 - 45200) = $ 10,800

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