Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays a

Question

Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4000 per year if alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3000 per year. Total annual revenue from pottery sales is $72,000. Calculate the accounting profit and the economic profit for Gomez

Explanation / Answer

Explicit costs: $12,000 for the helper + $5,000 of rent + $20,000 of materials) = Implicit costs: $4,000 of forgone interest + $15,000 of forgone salary + $3,000 of entrepreneurship = Accounting profit: $72,000 of revenue - $37,000 of explicit costs)= Economic profit $72,000 - $37,000 of explicit costs - $22,000 of implicit costs= His yearly expenses are $12K + $5k + $20K = $37,000. His gross income is $72,000, so his net is $72K - $37K = $35,000. Since he has $40K invested, he's nearly doubling his money every year. But if he could sell his equipment for $40K (a big maybe) and invest it and get a $4K return from it, and then go to work for his competitor and be paid $15K, then his income would be $19K. His entrepreneurial talents might or might not make him any money in his new job. (The competitor who's made him the offer thinks he is worth $15,000, so presumably that is his estimate of Gomez's total worth, including his entrepreneurial talents.) So what Gomez has to decide is, would he rather work for himself and make $35K per year, or for the other guy & make $19K

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