Assume a firm had a total revenue of $50million, and used $30 million in labor and materials to generate that revenue. Other costs include $100,000 in forgone interest, economic depreciation of $20,000 and normal profit of $65,000. Calculate the economic profit to the firm a) $19,803,000 b) $19,815,000 c) $19,856,000 d) $20,000,000 . . . . . . . . . . . . . … answer was B) Why question is why is normal profit considered a cost in the calculation? usually profit implies a gain ie revenue??
think about the oppotunity cost.
agree with Oops normal profit is considered as a kind of oppotunity cost
How is the economic profit $19,815,000 (B). can some one explain. Thx
$50million, and used $30 million in labor and materials to generate that revenue. Other costs include $100,000 in forgone interest, economic depreciation of $20,000 and normal profit of $65,000. Calculate the economic profit to the firm 50 M - 30 M - .1 M - .02 M - .065 M = 19.815 M
Total Revenue = $50M Labor and Material = $30M Revenue - Operating Expense = Operating Profit = 20M (relates to the Accounting Profit) but we need to subtract the others foregone costs too, to get to the real Economic Profit Other costs : $100K Economic Depreciation : $20K Normal Profit: $65K (this is the cost of managements’ entrepreneurial skills) 20,000K - 100K - 20K - 65K = 19815K Answer is ‘B’ - Dinesh S
I don’t understand the $65k portion. Can someone explain in more detail? Thanks
Normal profit is kindoff like the required return for management’s expertise. Besides the various factors of production employed and their associated costs (depreciation (Machinery), labor, Forgone interest (Capital), you have management as well. Normal profit is opportunity cost of that.
So the 65,000 is forgone… that makes sense.
what do we mean by economic depreciation here? can someone elaborate for me?
I think it’s the actual depreciation vs accounting depreciation (which is an estimate) but I don’t think we shouldn’t go in more depth than that since it is a pretty straight forward question.
Consider ‘Normal Profit’ as sitting home jobless for a month or so. Had you been working somewhere, employed in some firm, you would be getting some monthly salary. By sitting home, you have foregone that amount and that’s precisely what’s called the Normal Profit (thought I agree that the ‘Profit’ term associated to the opportunity cost component is a bit misleading … but then that’s the way the cookie crumbles … Said in Jim Carry’s tone) - Dinesh S