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, he cashed in $100,000 in bonds that earned 10 percent interest annually to buy a software company, Extreme Gaming. In the first year, the firm sold 11,000 units of software at $75 for each unit. Of the $75 per unit, $55 goes for the costs of production, packaging, marketing, employee wages and benefits, and rent on a building. The economic profits of Harvey's firm in the first year were:

A. $605,000
B. $825,000
C. $655,000
D. $150,000

Answer 1

a) $160,000

Step-by-step explanation:

Economic Profit is calculated by deducting the opportunity cost and monetary costs from the revenue. Whereas Accounting Profit can be calculated by deducting the only monetary costs from the revenue.

Economic profit = Revenue - Opportunity cost - Monetary cost

Revenue = 11,000 units x $75 = $825,000

Opportunity costs

Salary = $45,000

Entrepreneurial income = $5,000

Interest Income = $100,000 x 10% = $10,000

Total Opportunity cost = $60,000

Monetary costs

Cost = 11,000 units x $55 = $605,000

Economic profit = $825,000 - $60,000 - $605,000 = $160,000