# Two former MBS students worked in the world bank at a salary of RS. 30,00,000 each, for one year after they graduated. After a year they decided to quit their job and start a research institute. They used Rs. 15,00,000 to overheads (i.e computer, furniture etc. ).
For the next year, they took Rs. 150,00,000 in revenue each year, paid five research assistants Rs. 10,00,000 annually each and rented an office for Rs. 10,00,000 per year with the miscellaneous expenses Rs. 5,00,000 per year.
a) Define accounting cost and economic cost.
a) Define accounting cost and economic cost.
b) Compute accounting profit and economic profit. Should they remain in research institute after the year, if they are indifferent between working for themselves or other in a similar capacity ?
a) The definition of accounting cost and economic cost are as follows :
Accounting costs are those cost, that a firm actually pays for the product. It is also called 'Explicit Cost'. In simple words, Accounting costs are the actual out-of-pocket expenditures of the firm that is made to :
- Purchase inputs or
- Hire the inputs
Mathematically,
Accounting Cost = Direct Material + Direct Labor + Direct Overheads + Indirect Expenses + Selling and Distribution Expenses + Administrative Expenses + Legal Expenses + Management Expenses + Staff Expenses + Other Fixed and Variable Cost + Miscellaneous Expenses
Economic Cost are those cost, that a firm pays implicitly as well as explicitly. In simple words, it is the sum of implicit cost and explicit cost. It includes all the cost related to the product as well as any opportunity cost incurred therein.
In other words, Economic Costs are the cost at which the firm is able to cover its product cost as well as the normal return on its owned resources as a part of cost.
Mathematically,
Economic Cost = Accounting Cost (as mentioned above ) + Implicit Rent + Implicit Wages + Implicit Interests + Any Entrepreneurs opportunity Cost
b) Computation of Accounting Profit and Economic Profit :
Let us represent,
Total Revenue = TR = 150,00,000
Total Cost = TC
Accounting Cost = AC
Economic Cost = EC
Economic Profit = EP
Accounting Profit = AP
Entrepreneurs opportunity Cost = IC
Given,
There are two former MBS students who has worked in the world bank at a salary of RS. 30,00,000 each for one year after they graduated.
This implies, IC = Rs. 30,00, 000 x 2 = Rs. 60,00, 000
We know,
AP = TR - AC = 150,00,000 - 80,00,000 = Rs. 70,00,000
Where,
AC = Overhead Cost + Indirect Expenses (Rent Expenses) + Miscellaneous Expenses
= 15,00,000 + 50,00,000 (i.e 10,00,000 x 5) + 5,00,000 = Rs. 80,00,000
Similarly, we know -
EP = TR - (AC + IC ) = 150,00,000 - ( 80,00,000 + 60,00,000 ) = Rs.10,00,000
Therefore, we get Accounting Profit as Rs. 70,00,000 and Economic Profit as Rs.10,00,000 respectively.
Analysis:
Since, both of the former MBS student is able to gain overall economic profit of Rs.10,00,000 , it is advisable to continue the research job in research institute rather than working in the world bank , if they are indifferent between working for themselves or other in a similar capacity.
Note :
- The above question is adopted from the question asked to the students of Post Graduates (Masters level ) by Faculty of Management, Tribhuvan University, Nepal in the year 2014 ( Question No.10 ).
- The above problem is taken as a base to clear the concept of accounting cost and economic cost in practical scenario.
Some Useful Links -
- Characteristics of Managerial economics and Role of Managerial Economics in Business Decision Making
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