Alex has been working as a chef in a large restaurant for many years. He has been earning a salary of $60,000 per year. He has always dreamt of starting a catering business. One day, he decides to do it. He quits his job. He needs money to pay costs for the business, so he withdraws $50,000 from his bank savings account, which had been earning 4% interest revenue. He hires an assistant and a kitchen; and buys some ingredients for cooking ($20,000). In the first year, he sells $80,000 worth of food; pays his assistant $25,000; and pays $12,000 for the hire of the kitchen. What is his economic profit for the year?

Question

BlackTom AI · Accepted Answer

Let’s break down the scenario step by step to distinguish between explicit costs and opportunity costs.

First, identify the revenue for the year: the chef sells food totaling $80,000. This is the top line of the income statement for economic profit purposes.

Next, list the explicit (out-of-pocket) costs incurred in starting and running the business for the year: wages for the assistant ($25,000), the kitchen rental ($12,000), and the cost of ingredients ($20,000). Adding these gives explicit costs of 25,000 + 12,000 + 20,000 = 57,000.

Now account for opportunity costs, which are the economic costs of forgoing alternative choices. The owner quit a salary job paying $60,000 per year, so the foregone salary is an opportunity cost of 60,000. Additionally, by withdrawing $50,000 from savings earning 4% interest, he loses potential interest revenue of 0.04 × 50,000 = 2,000. These are not shown on a cash flow statement but are included in economic profit calculations as costs beyond explicit outlays. Their total is 60,000 + 2,000 = 62,000.

Combine explicit costs and opportunity costs to obtain total economic costs: 57,000 (explicit) + 62,000 (opportunity) = 119,000.

Finally, compute economic profit as revenue minus total economic costs: 80,000 − 119,000 = −39,000.

Therefore, the economic profit for the year is negative $39,000. The negative result reflects that, when considering both explicit costs and the opportunity costs of the owner’s time and capital, the venture did not cover its combined costs in the first year.

Note: If you only looked at accounting profit (revenue minus explicit costs), you would get 80,000 − 57,000 = 23,000, which is not the same as economic profit because it omits the opportunity costs discussed above.

MUF0061 Economics Unit 1 - Semester 2, 2025 Revision Quiz: Economic Profit (5 - 10 minutes)

View Explanation

Log in for full answers

Similar Questions

An industry is characterized by positive economic profits. This means that

The type of profit that considers opportunity costs is…

If the firm produces 10 units of output, its economic profits will equal

Greencom is currently producing 20 units of output. At this level of output, Greencom’s marginal revenue is $6, marginal cost is $6, and average total cost is $9. If Greencom operates in a perfectly competitive market and sells all 20 units of output for $10 per unit, it can be concluded that

Which of the following best describes the implication of a firm earning zero economic profit?

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler