Jack is going to chop 900 lawns and get $30,000 in revenue. He can give his capital on lease equipment for $3200. Assume that fuel and other expenses including marketing, billing, bookkeeping etc, come to $1800. This means he has cash income of $25,000. Is this his profit?
Assume that Jack puts 9 hours a day for the business and for a total of 900 hours for the season. In that case, on an average, Jack is getting just under $30 an hour. He should not consider all this as a profit.
Let as assume that Jack could earn $32 an hour by working in an office. Now if we include the value of his time, ($32)(900) = $28,800, then the lawn chopping business loses $1800. In other words, he should better be working in an office rather than starting his lawn-chopping business.
On the other side, let us assume that Jack’s best option is to make $15 an hour. Then the lawn chopping business is a better option. But to compute his real profit he should less $15 an hour from his proceeds. Multiplying $15 an hour by 900 hours provides $14500 in salary. Now subtracting this from $25,000 gives $10500 of economic profit.
So if Jack does not go for the $10500 salary, then economists would call this as his opportunity cost. Opportunity cost is defined as what a person needs to give up in order getting something.
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