Question

PROBLEM #4 Charlotte just finished a year of running her own leather business. During that year, the company generated $400,000 in revenues. The total cost of resources that she bought in the market was $170,000. This broad category includes the costs of raw materials, wages, and computers. The total cost of resources owned by the firm was $65,000. This category includes economic depreciationand foregone interest. Economic depreciation is the fall in market value of a company's capital over a given length of time, and foregone interest is the interest that Charlotte is giving up by choosing to purchase machines instead of stocks or bonds. Finally, in any other industry, Charlotte could expect to earn – on average – $45,000 in profit, and enjoy a salary of $55,000 per year. Therefore, the total cost of resources supplied by her, the owner, is $100,000. The breakdown of Charlotte's many accounts is:

Answer 1

Accounting Profit = Revenue – Explicit Cost

= $400,000 - $170,000

= $230,000

Economic Profit = Revenue – (Explicit Cost + Implicit Cost)

= $400,000 – ($170,000+$165,000)

= $400,000 – $335,000

= $65,000

Note:

Explicit Cost = Cost of Resources Bought in the Market = $170,000

Implicit Costs = Cost of Resources Owned by the Firm + Cost of Resources Supplied by the Owner

= $65,000 + $100,000

= $165,000