Question

One former MSU student decided to open a lawn service and landscaping company.            During the first year, she paid rent of $5,000, wages to employees of $50,000, and $10,000            for supplies (gas, oil, and so on). To start this business, she quit her previous job that had paid her $40,000 per year. Her mother invested $10,000 in the business, which was used to           acquire equipment. The company earned $106,000 in revenue in the first year.

3i.        The private explicit cost in the first year is

            ____________________

3ii.       If the average investment in the economy earned a 10% return this year, implicit private cost            for this business is

            ____________________

3iii.      Which is a correct statement about the economic profits of the business in the first year?

            a.         If the average investment in the economy earns a 10% return, economic profits were                                     zero.

            b.         The investor in this business earned a 10% return on investment in the first                                        year.

.           c.         This lawn/landscaping business would have had negative economic profits if the                               average investment in the economy generated a 15% return that year.

            d.         All of the above are correct.

            e.         None of the above is correct.

3iv.      Suppose the state government levied an “environmental tax” on this lawn/landscape business equal to $1,000 per year. The effect of the tax is to

            a.         increase the firm’s average cost, but not the marginal cost.

            b.         increase private implicit cost.

            c.         increase variable cost, but not fixed cost.

            d.         increase social cost, but not private cost.

            e.         have no effect on cost.

Answer 1

ANSWER:-

3(i)

The cost on hired or purchased factors which involves direct money payment is known as explicit cost.

The explicit cost are : Rent = $5,000

Wages to employees $ 50,000

Gas and oil $ 10,000

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Thus total explicit cost is $ 65,000

Answer: The private explicit cost in the first year $65,000

(ii)

Implicit cost is the cost imputed on the self owned factors or services where there is no direct money payment. Her mother invested $10,000 which would have been earned 10% interest if lend out to orther investors or deposited in the bank. The interest imputed on such amount is implicit cost.

Answer: If the average investment in the economy earned a 10% return this year, implicit private cost for this business is $51000 (value of previous job=$40000+self owned capital = $10000+ interest on self owned capital = $1000).

(iii)

Economic profit = total revenue - Total cost (Implicit + explicit cost)

Total revenue = $106000

Total cost = Explicit cost $65000

Implicit cost = self owned service = $40000. self owned capital $10000, interest on self owned capital $1000. Total implicit cost = $51000.

total cost is $116000.

Economic profit = $106000 - $116000 = $10000

Answer: e. none of the above.

(iv).

A tax is a variable cost. The imposition of environmental tax increases the variable cost.

Answer: c. Increase the variable cost, but not fixed cost.

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