ME-Class Assignment 1

Problem

● A trained mechanic has started a repair shop by investing his own capital
of say Rs.50000.

● His shop is located in the garage of his own house such that he pays no
rent.

● Annually, he makes a net income of Rs.100000 i.e. the difference

between the revenue earned (Rs.250000) and his materials and all other
explicit costs (Rs.150000).

● Had he not started and run his business, the mechanic himself could have
earned a monthly wage of Rs.5000 i.e. an actual salary of Rs.60000

● Similarly, had he invested his capital of Rs.50000 in the bank, he would

have got an annual return of 10% on it i.e. Rs.5000.

● His garage would have fetched a monthly rent of Rs.2000 i.e. an annual
rent of Rs.24000.  

Q. Calculate ACCOUNTING & ECONOMIC PROFIT.

 SOLUTION
Mechanic’s Total Revenue: ₹2,50,000
Material with all other explicit costs: ₹1,50,000
Net Income: ₹1,00,000

Hadn’t he started the business, he would have

Earned a salary of ₹60,000 pa
Earned Interest on his own capital of ₹50,000 at 10% rate i.e. ₹5,000
Earned ₹24,000 pa as rent of garage

Opportunity Cost
Salary + Interest + Rent:
₹60,000 + ₹5,000 + ₹24,000 = ₹89,000

Accounting Profit
Revenue – Cost:
₹2,50,000-₹1,50,000 = ₹1,00,000

Economic Profit
Accounting Profit – Opportunity Cost:
₹1,00,000 - ₹89,000 = ₹11,000
Mechanic started repair shop by investing his own capital of ₹50000. His shop was located in
the garage of his own house so he does pay any rent. His total revenue is ₹250000 and his
explicit cost was 150000. His net income was ₹100000. Had he not started a business he
would have been in ₹11000 loss as the opportunity cost is ₹89000 and the profit in business
is ₹100000. Opportunity cost included his salary, interest on capital and the rent of garage.
From the data above we can conclude that starting a business was more profitable.