Bella Inc. is a bakery business that sells cakes online. Last year, the company sold 40,000 cakes at a price of $5 per unit. The total costs for the year consisted of $30,000 in rent, $50,000 in labour, $20,000 in materials, and $10,000 in miscellaneous costs. The owner of Bella Inc. gave up her job working at another company for $90,000 a year. She also invested her retirement savings in the business, which she believes could have earned $10,000 in interest during the year if it had been invested.
1. Calculate Bella Inc.’s total revenue, accounting profit, and economic profit.
Show formulas and calculations.
a) Total revenue (Thinking /2)
b) Accounting profit (Thinking /3)
c) Economic profit (Thinking /3)
2. Should the owner of Bella Inc. stay in business or go back to her previous job?
Explain your answer using economic terms where possible
1. To calculate Bella Inc.'s total revenue, accounting profit, and economic profit, we will use the given information.
a) Total revenue:
Total revenue can be calculated by multiplying the number of cakes sold by the price per unit.
Total revenue = Number of cakes sold * Price per unit
Total revenue = 40,000 * $5 = $200,000
b) Accounting profit:
Accounting profit is calculated by subtracting total costs from total revenue.
Total costs = Rent + Labour + Materials + Miscellaneous costs
Total costs = $30,000 + $50,000 + $20,000 + $10,000 = $110,000
Accounting profit = Total revenue - Total costs
Accounting profit = $200,000 - $110,000 = $90,000
c) Economic profit:
Economic profit takes into account all explicit and implicit costs, including the owner's forgone salary and the lost interest on retirement savings.
Economic profit = Accounting profit - Implicit costs
Implicit costs = Owner's forgone salary + Lost interest on retirement savings
Implicit costs = $90,000 (forgone salary) + $10,000 (lost interest) = $100,000
Economic profit = $90,000 - $100,000 = -$10,000 (Loss)
2. Based on the calculation of economic profit, Bella Inc. has incurred a loss of $10,000. In economic terms, this means that the owner's total costs, including both explicit and implicit costs, exceed the total revenue generated by the business.
If the owner goes back to her previous job, she would earn a salary of $90,000 and avoid the $10,000 loss. This suggests that the owner would be better off financially by returning to her previous job.
However, it's important to consider other factors such as personal satisfaction, passion for the bakery business, and the potential for future growth. Economic profit only measures financial gain, and individual preferences and non-monetary factors should also be taken into account when making this decision.