Chapter 1. Chapter 9

Step 1

Work It Out
Work It Out
Chapter 9
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Question

Hiro owns and operates a small business that provides economic consulting services. During the year he spends $57,000 on travel to clients and other expenses. In addition, he owns a computer that he uses for business. If he didn’t use the computer, he could sell it and earn yearly interest of $100 on the money created through this sale. Hiro’s total revenue for the year is $100,000. Instead of working as a consultant for the year, he could teach economics at a small local college and make a salary of $50,000.

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Remember that accounting profit is only concerned about revenue and monetary costs. For Hiro, operating his business providing economic consulting services generates an economic profit of $43,000 ($100,000 - $57,000). For review see section “Accounting Profit versus Economic Profit.”
What is Hiro’s accounting profit?
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Step 2

Question

Hiro owns and operates a small business that provides economic consulting services. During the year he spends $57,000 on travel to clients and other expenses. In addition, he owns a computer that he uses for business. If he didn’t use the computer, he could sell it and earn yearly interest of $100 on the money created through this sale. Hiro’s total revenue for the year is $100,000. Instead of working as a consultant for the year, he could teach economics at a small local college and make a salary of $50,000.

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The difference between economic and account profit is that economists consider the opportunity cost which in this case includes the cost of giving up his job as an economics teacher and also the lost interest he could earn by selling his computer. For Hiro, he will earn an economic profit of -7,100. We start with his accounting profit and subtract out the value of his next best alternatives or $43,000 - $50,000 - $100 = -$7,100. Economic profit is negative, which implies the opportunity cost, the value of his next best alternative is larger than the accounting profit. For review see section “Accounting Profit versus Economic Profit.”
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Step 3

Question

Hiro owns and operates a small business that provides economic consulting services. During the year he spends $57,000 on travel to clients and other expenses. In addition, he owns a computer that he uses for business. If he didn’t use the computer, he could sell it and earn yearly interest of $100 on the money created through this sale. Hiro’s total revenue for the year is $100,000. Instead of working as a consultant for the year, he could teach economics at a small local college and make a salary of $50,000.

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