Question

Sarah is currently working for an accounting consulting firm, and her annual salary is $60,000. She is considering, however, to open her own business of art gallery. If Sarah runs her own business, then she will have to give up the current job in the firm. With the business, Sarah will provide the space for artists to display their works, and when a piece of art is sold, she will receive a certain amount of fee from the artist. She expects the business will generate $300,000 revenue per year, and the expenses to run the business, which includes the lease, utility, etc., will be $200,000. Compute the expected annual accounting and economic profits from the business.

Answer 1

Accounting profit does not consider opportunity cost of production while the economic profit consider the opportunity cost as well. Thus, economic profit tends to be lower than accounting profit if opportunity cost exists.

Accounting Profit:

= Revenue - Explicit Cost

= 300 000 - 2 00 000

= $ 100 000

Economic profit:

= Revenue - Explicit cost - opportunity cost

= 3 00 000 - 2 00 000 - 60 000

= $ 40, 000