Suppose winston's annual salary as an accountant is $60,000, and his financial assets generate $4,000 per year in interest. one day, after deciding to be his own boss, he quits his job and uses his financial assets to establish a consulting business, which he runs out of his home. to run the business, he outlays $8,000 in cash to cover all the costs involved with running the business, and earns revenues of $150,000. did winston make a good decision? support your answer by showing your calculations and explain your answer with economic terms.
Winston took a very good decision.
If Winston is making economic profit then the decision is good
Economic profit=Total revenue-implicit cost - explicit costs
implicit cost= opportunity cost of best alternative and explicit cost is accounting costs
The economic profit is positive, a good indicator that Winston took a good decision.
Implicit cost is the cost which is an income foregone internally, that is not the exact opportunity cost, here opportunity cost is salary foregone, that is $60,000.
But implicit cost would be $4,000 if the financial assets are now used in business, and are not left as they are.
Implicit cost is internally generated opportunity cost.
Since here he outlays, $8,000 let us say these were used earlier as financial assets to generate revenue, now $4,000 would be considered as implicit cost, that is earlier generated revenue from internal funds.
Economic profit is calculated as:
Economic profit = Total Revenues – Total Cost
Total cost both includes explicit and implicit cost. In this case, the explicit cost is $8,000 while the implicit cost is $64,000. Explicit cost is a direct payment made to run the business while implicit cost is the opportunity as accountant that is lost. Therefore,
Economic profit = $150,000 – ($8,000 + $64,000)
Economic profit = $78,000