Question

The sole proprietor of the Milwaukee Machine Company generates an annual accounting profit of $78,000. She has a standing salary offer of $35,000 a year to work for a large corporation. If she had invested her capital outside her own company, she estimates it would have returned $22,000 this year. What is the sole proprietor’s economic profit?
A. $0
B. $13,000
C. $21,000
D. $43,000

Answer 1

Answer:

C. $21,000

Explanation:

Economic profit is accounting profit less implicit cost or opportunity cost.

Opportunity cost is the next best option forgone when one alternative is chosen over other alternatives.

The next best option for the sole proprietor took is to work at the large firm. Thus her opportunity cost is  $35,000.

If the capital wasn't used in setting up the business, it would have earned $22,000. This amount is its opportunity cost.

Total opportunity cost = $22,000 +  $35,000 =$57,000

Accounting profit = $78,000 - $57,000 = $21,000

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