Question

Sebastian decides to open a tree farm. When deciding to open his own business, he turned down two separate job offers of $25,000 and $30,000 and withdrew $20,000 from his savings. Sebastian's savings account paid 3 percent interest. He also borrowed $20,000 from his brother, whom he pays 2 percent interest per year. He spent $15,000 to purchase supplies and earned $50,000 in revenue during his first year. Which of the following statements is correct? a. Sebastian's economic profit is -$16,000, and his accounting profit is $14,600.​b. Sebastian's economic profit is $4,600, and his accounting profit is $35,000. ​c. Sebastian's economic profit is $4,000, and his accounting profit is $34,600.​d. Sebastian's economic profit is -$16,000, and his accounting profit is $34,600. ​

Answer 1

Answer: C. Sebastian's economic profit is $4,000, and his accounting profit is $34,600.

Explanation:

Total Revenue = $50,000

Purchase of supplies = $15,000

Loan = $20,000 at 2% interest

Personal saving withdrawal = $20,000

Interest on personal savings = 3%

Accounting profit = Revenue - Expenses

Revenue = $50,000

Expenses = purchase in supplies + interest in loan

Expenses = $15,000 + (0.02 × 20,000)

Expenses = $15,000 + $400 = $15,400

Accounting profit = $50,000 - $15,400 = $36,600

Economic Profit = Accounting profit - Opportunity cost

Here best opportunity foregone = $30,000

Interest forgone on personal saving= $20,000 X 0.03 = $600

Total opportunity cost = $30,000 +$600 = $30,600

Thus Economic Profit = $34,600 - $30,600

= $4,000