Question

Question 1

Adam, an engineer, working for a foreign oil and gas company earning RM96,000 per year is planning to give up his job and set up his own business. He estimates that renting an office would cost RM1,000 per month, hiring a secretary would cost RM1,500 per month and purchasing the required supplies cost him RM12,000 per annum. He estimates that his total revenue for the year would be RM180,000.

1. Calculate the business annual:

i) Explicit cost

ii) Implicit cost

iii) Economic profit

b. Explain briefly whether Adam should start his own business if the total revenue decreases by RM10,000.

Answer 1

(i) Explicit cost is cost that involves direct payment made to others in the course of running a business, such as wage, rent and materials.

Explicit cost per month= RM1,000 (rent) +  RM1,500 (salary of secretary) = RM 2,500

Explicit cost per year= 12 x RM 2,500 + RM12,000 (supplies) = RM 30,000 + RM 12,000

Explicit cost per year= RM 42,000

(ii) Implicit costs do not involve any actual payment. They represent opportunity costs, that is, cost of next best alternative foregone.

Adam's salary of RM 96,000 per year from his previous job will be his implicit cost.

Implicit cost= RM 96,000

(iii) Economic profit is the monetary costs and opportunity costs a firm pays and the revenue a firm receives.

Economic Profit= Total Revenues - (Explicit Costs + Implicit Costs)

Economic Profit= RM 180,000 - (RM 42,000 + RM 96,000) = RM 180,000 - RM 138,000

Economic Profit = RM 42,000 per year

(iv) If the total revenue decreases by RM 10,000 then it becomes 180,000 - 10,000 = RM 170,000.

Adam's economic profit becomes 42,000 - 10,000 = RM 32,000

Yes, Adam should start his own business as the economic profit is positive and he earns more by start a business than he does in job.