Harvey quit his job at the University of Toronto where he earned $45,000 a year,the same as other employees of normal ability,the same as other employees of normal ability.But Harvey is unusually talented in another area,and he figures his entrepreneurial talent,or forgone entrepreneurial income,to be $5000 a year.He cashed in $100,000 in bonds that earned 10% interest annually to buy a software company,Extreme Gaming.In the first year,the firm sold 11,000 units of software at $75 per unit.Of the $75 per unit,$55 goes for the costs of production,packaging,marketing,employee wages and benefits,and rent on a building.
-Refer to the above information.If the price of the product increases to $85,then the economic profit will be
A) $60,000.
B) $220,000.
C) $270,000.
D) $330,000.
E) $250,000.

Question

Quizplus · Accepted Answer

To calculate the economic profit, we need to first calculate the total revenue and total costs.

Total revenue = Price per unit x Quantity sold 
Total revenue = $75 x 11,000 = $825,000

Total costs = Variable costs + Fixed costs 
Variable costs = $55 x 11,000 = $605,000 
Fixed costs = $100,000 (the amount Harvey invested to buy the software company)

Total costs = $605,000 + $100,000 = $705,000

Total profit = Total revenue - Total costs = $825,000 - $705,000 = $120,000

Since Harvey's forgone entrepreneurial income is $5,000, his total economic profit is:

Economic profit = Total profit - forgone entrepreneurial income 
Economic profit = $120,000 - $5,000 = $115,000

If the price increases to $85 per unit, the new total revenue will be:

New total revenue = $85 x 11,000 = $935,000

Using the same calculations as above, the total costs will still be $705,000.

New total profit = $935,000 - $705,000 = $230,000

Harvey's new economic profit will be:

Economic profit = New total profit - forgone entrepreneurial income 
Economic profit = $230,000 - $5,000 = $225,000

The increase in price results in an increase of economic profit of $110,000 ($225,000 - $115,000).

Therefore, the answer is C. $270,000.

Harvey Quit His Job at the University of Toronto Where