Question

2. Calculating costs

Becky is working for an advertising firm making $50,000 per year but considers starting her own advertising company. Becky has determined that to launch the business, she needs to invest $80,000 of her own funds. The annual cost of running the business will include $75,000 for the rent of the office space, $190,000 for employee wages, and $6,000 for materials and utilities. Becky plans to manage the business, which means that she will have to quit her current job. Suppose that the interest rate (or rate of return) on investments in the economy is 5%.

Becky's total implicit cost per year is _____ .

Becky's total cost per year is _____ .

3. Definition of economic costs

Nick lives in San Francisco and runs a business that sells guitars. In an average year, he receives $722,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $422,000; he also pays wages and utility bills totaling $268,000. He owns his showroom; if he chooses to rent it out, he will receive $2,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Nick does not operate this guitar business, he can work as a paralegal and receive an annual salary of $21,000 with no additional monetary costs. No other costs are incurred in running this guitar business.

Identify each of Nick's costs in the following table as either an implicit cost or an explicit cost of selling guitars.

	Implicit Cost	Explicit Cost
The wholesale cost for the guitars that Nick pays the manufacturer
The salary Nick could earn if he worked as a paralegal
The wages and utility bills that Nick pays
The rental income Nick could receive if he chose to rent out his showroom

Complete the following table by determining Nick's accounting and economic profit of his guitar business.

	Profit
	(Dollars)
Accounting Profit
Economic Profit

Alternatively, the economic profit he would earn as a paralegal would be

.

If Nick's goal is to maximize his economic profit, he _____   stay in the guitar business.

True or false: Nick is not earning a normal profit because his profit is positive.

False

True

Answer 1

2. Calculating costs

First calculate the accounting or explicit cost.

Explicit or accounting costs are those that is paid to the various factors of production. In other words, these are the cost paid to the outsiders. In the given the explicit costs are

Rent of office = 75,000

Employees’ wages = 190,000

Materials and utilities = 6,000

Total explicit cost = 75,000+190,000+6,000 = 271,000

Calculation of Implicit Costs

Implicit cost includes the benefit of own investment and benefit of own services.

The salary left as working in advertising firm = 50,000

Invested own fund of 80,000, interest is 5%

Interest sacrificed by investing own money = 5% of 80,000 = 4,000

Implicit cost = 50,000 + 4,000 = 54,000

Becky's total implicit cost per year is $54,000

Total economic cost is equal to the explicit cost plus implicit cost

Total Cost = Explicit cost + Implicit cost

TC = 271,000 + 54,000 = 325,000

Becky's total cost per year is $325,000

3. Definition of economic costs

Nick lives in San Francisco and runs a business that sells guitars. In an average year, he receives $722,000 from selling guitars.

Sales = 722,000

Of this sales revenue, he must pay the manufacturer a wholesale cost of $422,000; he also pays wages and utility bills totaling $268,000. He owns his showroom; if he chooses to rent it out, he will receive $2,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Nick does not operate this guitar business, he can work as a paralegal and receive an annual salary of $21,000 with no additional monetary costs. No other costs are incurred in running this guitar business.

Identify each of Nick's costs in the following table as either an implicit cost or an explicit cost of selling guitars.

	Implicit Cost	Explicit Cost
The wholesale cost for the guitars that Nick pays the manufacturer		YES
The salary Nick could earn if he worked as a paralegal	YES
The wages and utility bills that Nick pays		YES
The rental income Nick could receive if he chose to rent out his showroom	YES

Explicit cost

Wholesale cost = 422,000

Wages and utility bills = 268,000

Total Explicit cost = 422,000 + 268,000 = 690,000

Implicit Cost

Rent of own showroom if given in rent = 2,000

Salary that could be earned = 21,000

Total implicit cost = 21,000 + 2.000 = 23,000

Accounting Profit = Total sales – Explicit cost

Accounting Profit = 722,000 – 690,000 = 32,000

Economic Profit = Accounting Profit – Implicit cost

Economic Profit = 32,000 – 23,000 = 9,000

Complete the following table by determining Nick's accounting and economic profit of his guitar business.

	Profit
	(Dollars)
Accounting Profit	32,000
Economic Profit	9,000

Alternatively, the economic profit he would earn as a paralegal would be 23,000.

If Nick's goal is to maximize his economic profit, he SHOULD stay in the guitar business.

True or false: Nick is not earning a normal profit because his profit is positive.

False