Suppose Dana quits her job as a lawyer where she made 6500 p

Suppose Dana quits her job as a lawyer, where she made $6500 per month, to open an ice cream shop. Suppose that Dana has revenue of $20,000 per month. Her monthly explicit costs are shown below.

Is Dana earning an accounting profit? Is she earning an economic profit?

How much revenue would Dana need to make each month in order for her to earn a ‘normal profit?

Solution

Total Revenue Dana earns is $20000 per month.

Total Explicit cost is $16250 per month.

Accounting profit is the difference between a firm’s total revenue and total cost excluding the cost of opportunity foregone. Accounting profit is revenue deducted from the explicit cost.

In Dana’s case, Accounting profit is positive and equal to (20000 – 16250) = $3750

On the other hand, economic profit takes into consideration implicit cost also, i.e. the cost of opportunity foregone. Dana would have made $6500 per month had she been continuing her lawyer job. So, when calculating economic profit, we deduct the sum of implict (opportunity) as well as explicit cost from the total revenue.

Thus economic profit is [20000 – (16250 + 6500)] = - $2750

This means that economic profit is negative, Dana is incurring a loss of $2750 in economic terms.

Normal profit is a condition when a firm’s total revenue is exactly equal to its total cost. This a a situation of break-even i.e. no profit no loss. For this to happen sum of explicit and implicit cost must be equal to total revenue. Therefore, Dana would need to make revenue of (16250 + 6500 = 22750) each month, in order to earn normal profit.

Normal profit condition is:

Total Revenue - (Explicit Expense + Implicit Expenses) = 0