You own and operate a bike store. Each year, you receive revenue of $200,000 from your bike sales, and it costs you $100,000 to obtain the bikes. In addition, you pay $20,000 for electricity, taxes, and other expenses per year. Instead of running the bike store, you could become an accountant and receive a yearly salary of $40,000. A large clothing retail chain wants to expand and offers to rent the store from you for $50,000 per year. How do you explain to your friends that despite making a profit, it is too costly for you to continue running your store?

(a) Find your accounting profit.

(b) Find your economic profit.

(c) Explain your decision.

a). Accounting profit=$80,000

b). Economic profit=-$10,000

c). It would be better to stop running the store since the opportunity cost of doing other things is higher. This means, it would be less costly if you decide to be an accountant and rent your store.

Explanation:

a). Accounting profit

The accounting profit can be expressed as;

P=R-E

where;

P=accounting profit

R=total revenue

E=expenditure

In our case;

R=$200,000

E=cost of bikes+electricity, taxes and other expenses

E = (100,000+20,000) = $120,000

replacing;

P = (200,000-120,000) = $80,000

Accounting profit=$80,000

b). Economic profit

The economic profit is the accounting profit including other opportunity costs. This means that if you decided to become an accountant and rent your store you would get total opportunities;

total opportunity cost=accountant yearly salary+rent

Total opportunity cost = (40,000+50,000) = $90,000

Economic profit=accounting profit-total opportunity cost

Economic profit=80,000-90,000=-$10,000, since the economic profit is negative, it would be advisable to exit the market

c). It would be better to stop running the store since the opportunity cost of doing other things is higher. This means, it would be less costly if you decide to be an accountant and rent your store.