Question

Gomez runs a small pottery firm. He hires one helper at $15,500 per year, pays annual rent of $5,500 for his shop, and spends $21,000 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 $6,500 per year if alternatively invested. He has been offered $20,500 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $7,000 per year. Total annual revenue from pottery sales is $87,000. Calculate the accounting profit and the economic profit for Gomez.

Answer 1

The accounting profit is $45,000 and economic profit is $11,000

Step-by-step explanation:

Accounting profit is nothing but the owner's profit or you can say business profit. This profit can be taken out by calculating all the revenue generated from business and subtract the revenue by the explicit cost. The explicit cost here means the cost which is incurred in the process of running the business which includes rent paid, wages of labor and material purchased etc.

ACCOUNTING PROFIT ( FOR GOMEZ) =

= TOTAL REVENUE EARNED FROM POTTERY - HELPER SALARY - RENT ON SHOP - AMOUNT SPENT ON MATERIALS

= $87,000 - $15,500 - $5,500 - $21,000

= $45,000

Economic profit is not that much different from the accounting profit with only difference being that in the economic profit , implicit cost will also be included with the explicit cost. Implicit cost can be said as the opportunity cost which in this case Gomez is missing by running his own business.

Implicit cost in this question will include -

1) $6,500 which Gomez could have gotten if he would had invested $40,000 in equipment

2) he could have earn $20,500 if he had work as potter for his competitor

3) his entrepreneurial talents are worth $7,000

So therefore the total implicit cost is equal to $34,000

ECONOMIC PROFIT = TOTAL REVENUE - EXPLICIT COST - IMPLICIT COST

= $87,000 - $42,000 - $34,000

= $11,000