Economic Profit Problem Sets

Rodriguez operates a variety store that provides an annual revenue of $480 000. Each year, he pays $25 000 in rent for the store, $15 000 in business taxes, and $350 000 on products to sell. He estimates he could put the $80 000 he has invested in the store into his friend’s restaurant business instead and earn an annual 20 percent profit on his funds. He also estimates that he and his family could earn a total annual wage of $90 000 if they worked somewhere other than the store. a. Calculate the total explicit costs and total implicit costs of running the variety store. b. What is the accounting profit of the variety store? c. What is the economic profit? d. In what way is economic profit superior to accounting profit as an indicator of the overall performance of this business? Given the advantages of economic profit as a performance indictor, explain why the concept of economic profit is not often used in accounting. e. Should Rodriguez consider closing down this business? Why?

Answers

A) Explicit Costs = rent 25000 + business taxes 15 000 + products to sell 350 000 = $390 000
Implicit Costs = annual wage 90 000 + 16 000 profit = $106 000 B) 480 000 – 390 000 = 90 000 C) 480 000 – 496 000 = - 16 000 D) The main reason someone opens a business or invests is the make a profit. Profit is the positive gain from an investment or business operation after subtracting all the expenses. There are two different ways to find profit the economic way or the accounting way. The economic profit is found by subtracting economic costs from total revenue. Mean while accounting profit is found by subtracting just explicit cost from revenue. The economic profit is not often used by accounting because accounting is calculated based on the Generally Accepted Accounting Principles (GAAP) which use facts while the economic profit uses possibilities. E) Yes Rodriguez should consider closing down his business. He should close because if