A few years ago, a construction manager earning $70,000 per year working for a r

Question

A few years ago, a construction manager earning $70,000 per year working for a regional home builder decided to open his own home building company. He took $100,000 out of one of his investment accounts that had been earning around 6% a year and used that money to start up the business. He worked hard the first year, hiring one employee (his only salary cost for the business was the $40,000 paid to this employee) and generated total sales of $1,000,000. Total material and subcontracted labor costs for the year were $900,000.

5.3. What is the economic profit or loss of the business?

Explanation / Answer

The Economic profit = Total revenue - Total economic Cost Total economic Cost = Administrative cost + Opportunity cost of the factors of production Opportunity cost of capital = 6% of 100,000 = 6,000 O.C of the manager ( what he could have earned if he didn't start business) = $70,000 Salary paid to employee = $40,000 Total material and subcontracted labor cost = $900,000 So total economic cost = 6,000 + 70,000 + 40,000 + 900,000 = 1,016,000 Total revenue = $ 1,000,000 So Economic Profit = 1,000,000 - 1,016,000 = -16,000 So he's actually having an economic loss of $16,000

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