Question

Peggy-Sue’s cookies are the best in the world, or so I hear. She has been offered a job by Cookie Monster, Inc., to come to work at $125,000 per year. Currently, she is producing her own cookies, and she has revenues of $260,000 per year. Her costs are $40,000 for labor, $10,000 for rent, $35,000 for ingredients, and $5,000 for utilities. She has $100,000 of her own money invested in the operation, which, if she leaves, can be sold for $400,000 that she can invest at 1 percent per year.

a. Calculate her accounting and economic profits.
b. Advise her as to what she should do.

Answer 1

Answer:

a.Accounting Profits: amount of money you actually make

Accounting Profits from taking Job: 125,000+(1+.1)*40,000=169,000

Accounting Profits from owning Business: 260,000-40,000-10,000-35,000-5,000=170,000

Economic Profits: amount of money you make over the best secondary option

Economic Profits from taking Job: -1,000

Economic Profits from owning Business: +1,000

b.Advise her to continue to own Job

Answer 2

Answer:

accounting profit 170,000

economic profit   41,000

I would advise her to continue with their venture as it yields a better gain rather than beingan employee and invest their money elsewhere.

Explanation:

accounting profit:

revenues                  260,000

cost               40,000

rent                10,000

ingredients   35,000

utilities            5,000

Total explicit cost      (90,000)  

Accounting profit     170,000

The economic profit will take into consideraring their opportunity cost of the factors

wages opportunity cost: (125,000)

capital opportunity cost: 400,000 x 1% = (4,000)

Net economic gain         41,000