Question

two former northwestern university students worked in an investment bank at a salary of $60,000 each for 2 years after they graduated. together they saved $50,000. after 2 years, they decided to quit their jobs and start a business designing web sites. they used the $50,000 to buy computer equipment, desks, and chairs. for the next 2 years, they took in $40,000 in revenue each year, paid themselves $10,000 annually each, and rented an office for $18,000 per year. prior to the investment, their $50,000 was in bonds earning interest at a rate of 10 percent. are they now earning economic profits? explain your answer.

Answer 1

If they paid themselves $10,000 annually each, and rented an office for $18,000 per year. prior to the investment, their $50,000 was in bonds earning interest at a rate of 10 percent. The economic profits is $43,000.

How to find the economic profits?

First step is to find the opportunity cost per year

Opportunity cost = $60, 000 /2

Opportunity cost = $30 000

Second step is to find the opportunity cost of their capital in bond and the total opportunity cost  

Opportunity cost = 10% × $50,000

Opportunity cost =$5,000

Total opportunity cost = $60,000+$5,000

Total opportunity cost =$65,000

Third step is to find the total net profit

Total net profit=$40,000- $18,000

Total net profit =$22,000

Now let find the economic profit using this formula

Economic profit = Net profit- opportunity cost

Economic profit = $22,000-$65, 000

Economic loss = $43,000

Therefore the amount of $43,000 is the economic profit

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