Question

Harvey quit his job at State University where he earned $45,000 a year. He figures his entrepreneurial talent or forgone entrepreneurial income to be $5,000 a year. To start the business, be cashed in $100,000 in bonds that earned 10% interest annually to buy a software company, Extreme Gaming. In the first year, the firm sold 11,000 units of software at $75 each. Of the $75, $55 goes for the costs of production, packaging, marketing, employee wages and benefits, and rent on a building.

Required:
What's the economic profit generated by Extreme Gaming in the first year?

Answer 1

$160,000

Step-by-step explanation:

Economic profit = accounting profit - implicit cost

Accounting profit= total revenue - explicit cost

Total revenue =price x quantity sold

total revenue = 75 x 11,000 = 825,000

Explicit cost includes the amount expended in running the business.

explicit cost = 55 x 11,000 = 605,000

Accounting profit = 825,000 - 605,000 = 220,000

Implicit cost is the cost of the next best option forgone when one alternative is chosen over other alternatives

Harvey's implicit costs = amount he would have earned in the university + income from entrepreneurial talent + interest income

Interest income = 0.1 x 100,000 = 10,000

10,000 + 45,000 + 5,000 = 60,000

Economic profit =220,000 - 60,000 = 160,000