Question

Mitzi's Pet Salon hires you to determine the company's status. The data in Table 11.5 provides information on the company's annual costs and revenues. Mitzi spends at least 40 hours a week at her place of business. If she closed the salon, she could work for her competitor and earn $15,000 per year. She also owns the building that houses the salon and could rent it out for $18,000 per year if she closes her business. Calculate the economic cost and economic profit for Mitzi's Pet Salon. Would an accountant come to the same conclusion about the profitability of this firm? Explain

Answer 1

Based on the figures given for the business, we can calculate the following:

• Economic cost = $92,000
• Economic profit = -$2,000
• An accountant would not come to the same conclusion about profitability

Economic cost includes both implicit and explicit costs. Implicit costs are opportunity costs and explicit costs are the normal costs.

Economic cost here is therefore:

= Wages + Interest + Expenditure + Earnings if working for competitor (implicit cost) + Prospective rent income if rented out (implicit cost)

= 25,000 + 3,000 + 31,000 + 15,000 + 18,000

= $92,000

Economic profit:

= Total revenue - Economic cost

= 90,000 - 92,000

= -$2,000

An accountant would use accounting profit which is:

= Total revenue - Explicit costs

= 90,000 - 25,000 - 3,000 - 31,000

= $31,000

In conclusion, the company is making an economic loss.

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