Principles of Microeconomics / Unit 6 MIC 0506 worked example, 60 to 90 seconds
Computing Economic Profit
The idea
From a scenario, list revenue, then the explicit costs, then the implicit costs. Accounting profit is revenue minus explicit costs. Economic profit is accounting profit minus implicit costs. The implicit costs are what the owner's own resources would earn elsewhere: a forgone salary, forgone interest on money tied up, forgone rent on owned premises. If economic profit is positive the venture beats the alternatives; if negative, the owner would do better closing it, even with an accounting profit on the books.
In practice
Worked example: a bookkeeper leaves a job paying sixty-five thousand dollars to open a practice, putting fifty thousand of savings that earned four percent into it. Revenue is one hundred eighty thousand; rent is forty thousand and an assistant seventy thousand. Accounting profit is one hundred eighty minus one hundred ten, seventy thousand. Implicit costs are the sixty-five-thousand salary plus two thousand of forgone interest, sixty-seven thousand. Economic profit is three thousand dollars: the practice beats the job, barely.
Where people slip
Two errors. Counting the owner's salary as an explicit cost when she pays herself nothing; it is implicit whether or not a check is written. And stopping at accounting profit, which here would have suggested a comfortable seventy-thousand-dollar success when the true margin over the alternative is three thousand.
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