You use $40,000 of your own money to start a catering business. During the first year you earn a 5% return on that investment. If the current interest rate on savings is 8%, you earn an economic profit of

Question

Quizplus · Accepted Answer

Economic profit is calculated by subtracting the opportunity cost from the actual earnings. Here, the actual earnings from the catering business are 5% of $40,000, which is $2,000. However, if the $40,000 had been saved in an account offering an 8% interest rate, the earnings would have been $3,200. Therefore, the opportunity cost is $3,200 - $2,000 = $1,200. Since this is a cost not earned, it is a negative economic profit, hence -$1,200.

You Use $40,000 of Your Own Money to Start a Catering