Question

MICROECONOMICS--PRODUCTION AND COSTS WORKSHEET

John and Kelly McClain own THE MOVIE CONNECTION, a local video store that sells and rents videos, video games and miscellaneous items such as candy, popcorn, soda, etc. They opened their business last year after John decided to leave a lucrative legal career because of health problems. Kelly also decided to quit her job as a physical therapist and help John out with their new business.
John was earning, on average, $75,000 per year as a criminal defense attorney and Kelly had been earning $32,000 per year working part-time in the physical therapy unit at the local hospital. Together, they invested $50,000 they had saved in CDs earning 7.5 % interest yearly. They borrowed $450,000 to start their new venture and rented a building in a prime location downtown.

At the end of the first year, they had earned the following revenues and expenses:

   Video sales revenue           $   52,500
   Wages                       7, 500
   Utilities (water & electric)           12,000
   Video rental revenue               646,000
   Late fee revenue               32,000
   Garbage collection service           1,200
   Rent                       48,000
   New business loan payment           32,400
   Game rental revenue               104,000
   Full coverage insurance           6,000
   VCR rental revenue               1,300
   Video and game purchases           480,000
   Misc. revenue (candy, soda, etc.)       42,500
   Security monitoring fees           300
   Misc. purchases (supplies, etc.)       37,500
   VCR and video repair fees           600

Calculate the totals below using the figures from above.

Total Revenue:                      
   Explicit Costs:
   Accounting Profit:                  
   Implicit Costs:               
   Economic Profit:                  

Which of the expenses listed above would be considered FIXED costs?

How much are TOTAL FIXED COSTS?               __________________
How much are TOTAL VARIABLE COSTS?           __________________

Are the McClains earning a normal economic profit? If so, what does this mean?

Should the McClains continue running their own business? Why?    

Answer 1

Table 1 (Revenue)

Video sales revenue	52500
Video rental revenue	646000
Late fee revenue	32000
Game rental revenue	104000
VCR rental revenue	1300
Misc. revenue (candy, soda, etc.)	42500
Total	878300

Table 2 (Explicit Cost)

Wages	7500
Utilities (water & electric)	12000
Garbage collection service	1200
Rent	48000
New business loan payment	32400
Full coverage insurance	6000
Security monitoring fees	300
Misc. purchases (supplies, etc.)	37500
VCR and video repair fees	600
Video and game purchases	480000
Total	625500

Table 3 (Accounting Profit)

Revenue	878300
Explicit Cost	625500
Profit	252800

Table 4 (Implicit cost )

J's salary foregone	75000
K's salary foregone	32000
CD interest foregone	3750
Total	110750

Table 5 (Economic Profit )

Accounting Profit	252800
Implicit Cost	110750
Economic Profit	142050

• The fixed cost is those, which does not change with the amount of production or sales. It is incurred even the firm stop its operation.
  Table A (Fixed Cost)

  Utilities (water & electric)	12000
  Garbage collection service	1200
  Rent	48000
  New business loan payment	32400
  Full coverage insurance	6000
  Security monitoring fees	300
  Total	99900

• The variable cost is the cost that changes with the number of sales. Fixed cost plus the variable cost is the total cost.
  Table B (Variable Cost)

  Wages	7500
  Misc. purchases (supplies, etc.)	37500
  VCR and video repair fees	600
  Video and game purchases	480000
  Total	525600

• The normal economic profit implies zero economic profit. But the economic profit is positive for this business. Therefore, the business is earning an above-normal economic profit.
• As the economic and accounting profit both positive for this business, the owner should continue to run the business.