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# Comparison of Accounting & Economic Profits

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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 work for them at \$125,000 per year. Currently she is producing her own cookies, and she has revenues of \$245,000 per year. Her costs are \$40,000 for labor, \$10,000 for rent, \$35,000 for ingredients, and \$5,000 for utilities. She has \$1,000,000 of her own money invested in the operation, which if she leaves, can be sold for \$600,000; she can invest at 5 percent per year.

1. Calculate her accounting and economic profits. Advise her as to what she should do.
2. Assume that Peggy Sue's broker promises her a 10% return on her stock portfolio. Calculate her accounting and economic profits. Advise her as to what she should do.
3. Assume that her broker was wrongâ€”she can only get the original stock return of 5%, but assume that Cookie Monster, Inc., offers Peggy Sue \$150,000 per year. Calculate her accounting and economic profits. Advise her as to what she should do.

ACCOUNTING PROFITS
Revenue

Explicit Costs
Labor \$40,000
Rent 10,000
Ingredients 35,000
Utilities 5,000
Total Explicit Costs \$90,000

Accounting Profit / <Loss> \$155,000

ECONOMIC PROFITS (1)
Revenue

Explicit Costs
Labor \$40,000
Rent 10,000
Ingredients 35,000
Utilities 5,000
Total Explicit Costs \$90,000

Implicit Costs
Opportunity Cost of Owner's Time \$125,000
Opportunity Cost of Owner's Capital 30,000
(\$600,000 X .05 = \$30,000)
Total Implicit Costs \$155,000

Total Explicit Plus Implicit Costs \$245,000

Economic Profit / <Loss> \$-0-

ADVICE: Peggy-Sue should be indifferent to owning her own business or working for Cookie Monster on the basis of her economic profits. Perceptions of future trends or preferences to "work for oneself" may be the deciding factors. These have not been figured into this basic revenue-cost analysis.

ECONOMIC PROFITS (2)
Revenue

Explicit Costs
Labor \$40,000
Rent 10,000
Ingredients 35,000
Utilities 5,000
Total Explicit Costs \$90,000

Implicit Costs
Opportunity Cost of Owner's Time \$125,000
Opportunity Cost of Owner's Capital 60,000
(\$600,000 X .10 = \$60,000)
Total Implicit Costs \$185,000

Total Explicit Plus Implicit Costs \$275,000

Economic Profit / <Loss> <\$30,000>

ADVICE: Peggy-Sue should work for Cookie Monster on the basis of her economic profits (that is, a \$30,000 loss). The increase in the opportunity cost of capital due to the 10% required return generated an economic loss.

ECONOMIC PROFITS (3)
Revenue

Explicit Costs
Labor \$40,000
Rent 10,000
Ingredients 35,000
Utilities 5,000
Total Explicit Costs \$90,000

Implicit Costs
Opportunity Cost of Owner's Time \$150,000
Opportunity Cost of Owner's Capital 30,000
(\$600,000 X .05 = \$30,000)
Total Implicit Costs \$180,000

Total Explicit Plus Implicit Costs \$270,000

Economic Profit / <Loss> <\$15,000>

ADVICE: Peggy-Sue should work for Cookie Monster on the basis of her economic profits (that is, a \$15,000 loss). The increase in the opportunity cost of her time generated an economic loss.

https://brainmass.com/economics/utility-demand/comparison-accounting-economic-profits-249770