Situation:
You are an economic analyst and one of your clients is your Aunt Ginger. You have not met with her for a year, and she has just closed the books on her first year in business. Her accountant has informed her that she made a substantial profit, and she is very pleased. Her business, “Cookiebucks,” grossed $155,000 in sales for the year. She had to pay wages of $35,000 to her employees. The raw materials needed to bake the cookies cost $37,000. She also paid $12,000 in rent, $6,000 for electricity, $2,800 for advertising, and $1,200 for phone service.
Your Uncle Fred is not as pleased as Aunt Ginger, but he can’t figure out exactly why. In discussing the situation with you, he states that the two of them used $100,000 of their savings, which had been earning 10% interest, to start the business. Your aunt gave up her job as a middle manager at the local bank, which had been paying her $38,000 per year. Your uncle has worked almost every evening and weekend in the business, which meant he gave up overtime at his job; he estimates $15,000 worth. Finally, he mentions that he is tired all the time, which he wasn’t before the “Cookiebucks” business.
Determine the accounting profit (or loss) of the business.
List the opportunity (implicit) costs of the business.
Determine the economic profit (or loss) of the business. Show your work.
What advice would you give them as their economic analyst?
Your unhappy uncle wants to be compensated $4,000 for giving up being well-rested. Would that change your advice? How and why?