Question

Last year, Jarod left a job that pays $60,000 to run his own bike-repair shop. Jarod’s shop charges $65 for a repair, and last year the shop performed 3,000 repairs. Jarod’s production costs for the year included rent, wages, and equipment. Jarod spent $50,000 on rent and $100,000 on wages for his employees. Jarod keeps whatever profit the shop earns, but does not pay himself an official wage. Jarod borrowed $20,000 for the shop’s equipment at an annual interest rate of 5 percent. a. What is Jarod’s accounting profit? b. What is Jarod’s economic profit?

Answer 1

Answer:

(a) $45,000

(b) -$16,000

Explanation:

(a) Jarod’s accounting profit:

= Total revenue - Total cost

= (Price charge for repair × No. of repairs) - (Rent + wages)

= ($65 × 3,000) - ($50,000 + $100,000)

= $195,000 - $150,000

= $45,000

(b) Opportunity cost = Previous job earnings + Interest on equipment

                                  = $60,000 + $20,000 × 5%

                                  = $61,000

Jarod’s economic profit:

= Accounting profit - Opportunity cost

= $45,000 - $61,000

= -$16,000