Narrative Wolfgang is running his own Internet marketing firm. Two years ago he quit his job from a major Internet advertising company in order to start his Internet business. He used to make good money in his previous job. A couple of days ago the old boss called Wolfgang offering him his old job with the same salary. Wolfgang is now torn between going back to the old job and continuing with his own business. Help him with his decision. You need to consider two different scenarios that could emerge in the real world. The numbers under both scenarios are the same. Scenario A He borrowed some money from a bank to buy the required equipment. He rented an office downtown to conduct his business. He has to pay monthly premiums to an insurance company for insuring his office and equipment against theft and fire. He has hired a computer programmer on a full-time basis to help him out. The following table shows all the costs and benefits to consider. All the figures are monthly Lost salary (if he runs his own firm Interest paid to the bank on the loan Rent paid for the office Insurance premium paid Wage for the computer programmer Revenue from the business $10,000 $2,000 $2,500 $1,500 $6,000 $26,000 Scenario B He had some money in the bank that he had inherited from Aunt Hildegard. The money was earning some interest. He had withdrawn that money from the bank to buy the required equipment. He also needed an office to conduct his business. He was renting one of his bedrooms to a college student. He kicked that student out and converted that room into an office. He has to pay monthly premiums to an insurance company for insuring his office and equipment against theft and fire. He has hired a computer programmer on a full-time basis to help him out. The following table shows all the costs and benefits to consider. All the figures are monthly Lost salary (if he runs his own firm) Lost interest from withdrawing Aunt Hildegard\'s inheritance Forgone rent from converting the bedroom into office Insurance premium paid Wage for the computer programmer Revenue from the business $10,000 $2,000 $2,500 $1,500 $6,000 $26,000
Accounting profit = Revenues – Costs
Under scenario A accounting profit = 26000 – (2000 + 2500 + 1500 + 6000) = $14000
Under scenario B accounting profit = 26000 – (1500 + 6000) = $18500
Wolfgang should stay with his own business in both scenarios because he is earning economic profit in both scenarios. Economic profit is the profit after considering the opportunity costs in the accounting profit. Opportunity costs are the lost revenue making opportunities due to a certain decision.
Economic profit = Revenues – Costs – Opportunity costs
Under scenario A economic profit = 26000 – (2000 + 2500 + 1500 + 6000) – (10000) = $4000
Under scenario B economic profit = 26000 – (1500 + 6000) – (2000 + 2500 + 10000) = $4000
Enter “1” as answer in both scenarios for question 7
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