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CMA Foundation · Fundamentals of Business Economics and Management · Means of Production

Rohan starts a bakery in Pune. He invests Rs 4,00,000 of his own savings, which could otherwise earn 10% interest a year, and he gives up a job paying Rs 3,00,000 a year. Explicit costs for the year are Rs 9,00,000 and revenue is Rs 14,00,000. What is his pure economic profit (after normal profit and opportunity costs)?

His economic profit is Rs 1,60,000. Accounting profit is Rs 5,00,000 (14,00,000 less 9,00,000). Implicit costs are Rs 40,000 interest forgone plus Rs 3,00,000 salary forgone, totalling Rs 3,40,000. Subtracting these from accounting profit gives pure economic profit of Rs 1,60,000.

  1. ARs 5,00,000
  2. BRs 1,60,000Correct
  3. CRs 2,00,000
  4. DRs 1,00,000

Explanation

Accounting profit = 14,00,000 - 9,00,000 = Rs 5,00,000. Implicit costs: interest forgone 10% of 4,00,000 = Rs 40,000 plus forgone salary Rs 3,00,000 = Rs 3,40,000. Economic profit = 5,00,000 - 3,40,000 = Rs 1,60,000. Rs 5,00,000 is wrong because it ignores implicit costs.

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