Question

Alex withdrew $500,000 from an account that paid 5 percent annual interest and used the funds to purchase real estate. After one year he sold the property for $550,000. Alex's economic profit on this deal was:

Answer 1

Answer:

Economic profit =$25,000

Explanation:

Economic profit is the difference between revenue and implicit cost. Implicit cost is the sum of out-of-pocket accounting cost and opportunity cost.

opportunity csot is the value of the benefit sacrificed in favour of a decision.

Economic profit = Accounting profit - opportunity cost

Opportunity cost in Alex's situation is the interest lost or forgone by withdrawing the funds from an interest paying account.

Interest forgone = 5%× 500,000= $25,000

Economic profit = Revenue - cost of property - interest forgone

Economic profit = 550,000 - 500,000- 25,000=$25,000

Economic profit =$25,000

Answer 2

Answer:

Economic Profit = Accounting profit - opportunity cost

Accounting profit = $50,000 ($550,000 - $500,000)

Opportunity cost = $25,000 ($500,000 x 5%)

Economic profit = $25,000 ($50,000 - 25,000)

Explanation:

Economic profit measures profitability after deducting opportunity costs.  It is the accounting (normal) profit minus the opportunity costs.  In measuring economic profit, the revenue generated from a chosen option is used and the costs incurred under this option is deducted to arrive at the accounting profit.  Then, the opportunity cost of an option that is not option is deducted from the accounting profit, to arrive at the Economic profit.

Opportunity cost is the benefits that would have been enjoyed from an a forgone option.

Essentially, the economist and the accountant do describe profit similarly.  The economist always considers the opportunity cost, which the accountant does not bring into the equation.