Question

Suppose that a sole proprietorship is earning total revenues of Rs. 1,00,000 and is incurring explicit costs of Rs. 75,000. If the owner could work for another company for Rs. 30,000 a year, we would conclude that:

• A. The firm is incurring an economic loss.
• B. Implicit costs are Rs. 25,000.
• C. The total economic costs are Rs. 1,00,000.
• D. The individual is earning an economic profit of Rs. 25,000.

Answer 1

The correct option is A The firm is incurring an economic loss.

Economic profit is calculated as the difference between total revenue and total cost ( including the implicit costs).
In the given situation, the total cost to the proprietor would be the explicit cost plus the opportunity cost of what he could have earned if he could have worked in a company.
Economic Profit = Total Revenue - Total Cost (Explicit Cost + Implicit Cost)
Economic Profit = 1,00,000 - (75,000 + 30,000)
= - 5000
Thus, the proprietor is earning an economic loss. However, it must be noted that he is earning a profit in accounting sense.