Question

2. Definition of economic costs 

 Van lives in Chicago and runs a business that sells boats. In an average year, he receives $704,000 from selling boats. Of this sales revenue, he must pay the manufacturer a wholesale cost of $404,000; he also pays wages and utility bills totaling $286,000. He owns his showroom; if he chooses to rent it out, he will receive $3,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Van does not operate this boat business, he can work as an accountant and receive an annual salary of $20,000 with no additional monetary costs. No other costs are incurred in running this boat business.

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

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

                            Profit

                            (Dollars)

 Accounting Profit

 Economic Profit

 Altematively, the economic profit he would eam as an accountant would be _______ 

 If Van's goal is to maximize his economic profit, he _______  stay in the boat business.

 True or false: Van is earning a normal profit because his profit is negative.

 False

 True

Answer 1

Explicit cost are those expenditures that firm incur while purchasing goods and services from others to undertake production.

Following are the explicit costs -

1. The wages and utility bills that Van pays.

2. The wholesale cost for the boats that Van pays the manufacturer.

Implicit cost are the costs related to owner supplied resources.

Following are the implicit costs -

1. The salary Van could earn if he worked as an accountant.

2. The rental income Van could receive if he chose to rent out his showroom.

Calculate the accounting profit -

Accounting profit = Total revenue - Wages and utility bills - Wholesale cost paid to manufacturer of boats

Accounting profit = $704,000 - $286,000 - $404,000 = $14,000

The accounting profit is $14,000.

Calculate the economic profit -

Economic profit = Accounting profit - Foregone salary - Foregone rent

Economic profit = $14,000 - $20,000 - $3,000 = -$9,000

The economic profit is -$9,000.

Alternatively,

The economic profit he would earn as an accountant would be $20,000.

If Van's goal is to maximize his economic profit, he should not stay in boat business.

Van could earn normal profit when his economic profit is zero.

So,

The given statement is False.