Question

Anne Smith has been working as the executive chef for several well-known upscale restaurants in Atlanta for the past 15 years. She has recently inherited an old house in Virginia Highlands that she could rent out as is for $25,000 per year, but could also convert into a restaurant. Since she doesn’t like debt, she cashes in a $100,000 Bond paying 9% interest in order to raise funds to remodel the house into a restaurant. If she starts the restaurant she has to quit her job which pays $80,000 per year. The following is a list of yearly data which might be useful to put an income statement together. Show the accounting profit and then the economic profit. Explain explicit versus implicit costs and the relevance for her decision to open her own restaurant.

Cost of food, $350,000; utilities, 7,000; property taxes, 25,000; linen service, 4,000; flowers, $2,000; cooks and other help, $150,000; Average dinner bill, $48; Number of meals served, 12,500.

Thank you very much for helping.

Answer 1

The accounting cost is the explicit cost of production that the firm must incur to employ the factor of production. The economic cost is implicit cost that includes accounting and well as opportunity cost of the production.

The opportunity cost is the cost is the value of the next best alternative foregone in choosing a certain alternative. This is an economic cost and not included on the accounting cost.

The accounting profit is the difference between total revenue of the firm minus the accounting cost. The economic profit is however the difference between total revenue and economic cost.

In this case the explicit cost is cost o food, utilities, taxes, linen service, cooks and help, and flowers and the capital to remodel the house. Thus the explicit cost is

Then the accounting profit is

In this case the implicit cost is EC plus cost of rent foregone, wage foregone and interest forgone. Then the implicit cost is

Then her economic profit is