Question

Rita quit her job as dentist where she earned $150,000/year and converted a house that she owns into a museum for her collection of clocks. Before doing this, Rita had been renting the house out for $20,000/year. Rita hired 2 employees for her museum at a total cost of $50,000/year, and had to pay $10,000/year for utilities.  

Her museum brought in revenues of $125,000 the first year. Someone even offered her $1,000,000 to purchase her entire collection of clocks. She declined this offer.  

1) What is Rita's accounting profit during the year?
2. What is Rita's economic profit? Please explain.

I know that Accounting profit = total revenue - explicit costs and that Economic profit = total revenue - explicit costs - implicit costs. I am having trouble with figuring out what would be considered explicit costs vs what are considered implicit costs. Could you help me solve this problem?

Answer 1

Explicit costs = 50,000 + 10,000 = 60,000

Implicit costs = 150,000 + 20,000 = 170,000

1) Accounting profit = Total revenue - explicit costs = 125,000 - 60,000 = $65,000

2) Economic profit = Total revenue - explicit costs - implicit costs = 125,000 - 60,000 - 170,000 = $-105,000