Two university graduates, Bill and Steve, worked for an advertising agency at an annual salary of $40,000 each for 3 years after they graduated. Then, they decided to quit their jobs and start a partnership that designs and builds Web sites

They rented an office for $12,000 a year and bought capital for $30,000. To pay for the equipment, Bill and Steve borrowed money from a bank at an annual interest rate of 6 percent. During their first year of operation, the partners' total revenue was $100,000. The market value of their capital at the end of the year was $20,000. If Bill and Steve do not design Web pages, their best alternatives are to return to their previous job. a) What is the firm's economic depreciation? b) What are the partnership's costs? c) What is the firm's economic profit in the first year of operation?

a) The economic depreciation of the firm's capital is the market value of its equipment at the beginning of the year, $30,000, minus its market value at the end of the year, $20,000, so the economic depreciation is $10,000.
b) The partnership's costs are: the rent, $12,000; the interest expense, $1,800; the economic depreciation, $10,000; and, the opportunity cost of the owners' resources, which is the best alternative use of their resources, working at their previous job for $40,000 each, for a total of $80,000. therefore the total cost is $103,800.
c) A firm's economic profit is its total revenue minus its total cost. Bill and Steve's total economic profit is $100,000 - $103,800 = -$3,800, which means that the firm has an economic loss.