Gomez runs a small pottery firm. He hires one helper at

Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000 per year if alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3,000 per year. Total annual revenue from pottery sales is $72,000. 


Explanation

Explicit costs are the direct costs incurred from production: $37,000 (= $12,000 for the helper + $5,000 for rent + $20,000 for materials). Implicit costs are the costs that are indirectly incurred by the activity: $22,000 (= $4,000 of forgone interest + $15,000 of forgone salary + $3,000 of entrepreneurship).

a. Accounting profit = $35,000 (= $72,000 of revenue – $37,000 of explicit costs).

b. Economic profit = $13,000 (= $72,000 of revenue – $37,000 of explicit costs – $22,000 of implicit costs).