Philip owns and operates a gas station. Philip works 40 hours a week managing the station but doesn't draw a salary. He could earn $600 a week doing the same work for Terrance. The station owes the bank $100,000 and Philip has invested $100,000 of his own money. If Philip's accounting profits are $1,000 per week while the interest on his bank debt is $500 per week, the business's economic profits are
A) $500 per week.
B) -$100 per week.
C) $400 per week.
D) $0 per week.
E) $1,000 per week.

Question

Quizplus · Accepted Answer

To calculate economic profits, we need to subtract all explicit and implicit costs from total revenue. In this case, the explicit costs are the interest on bank debt, which is $500 per week ($100,000 x 0.5/52), and the opportunity cost of Philip's labor, which is $600 per week. Therefore, total explicit costs are $1,100 per week. The implicit cost is Philip's investment of $100,000 in the business, which could earn a return of 5% per year or $96.15 per week ($100,000 x 0.05/52). Total implicit costs are $96.15 per week. Total revenue is the accounting profit of $1,000 per week. Therefore, economic profits are:
$1,000 - ($500 + $600 + $96.15) = -$196.15 per week
Since economic profits are negative, the best choice is B. The gas station is not earning enough revenue to cover all costs, including the opportunity cost of Philip's labor and investment.

Philip Owns and Operates a Gas Station