Question

I run a small art firm. in the first year I hired one helper at 12,000 per year, paid annual rent of $5,000 for the shop, and spent $20,000 on materials. I have $40,000 of my own funds invested in equipment that could earn 4,000 per year if alternatively invested. I had been offered $15,000 per year to work as a artist for a competitor. I estimate my entrepreneurial talents are worth $3,000 per year. total annual revenue from art sales is $72,000.
a) what are explicit costs?
b) what are implicit costs?
c) what are fixed cost?
d) what are variable costs?

Answer 1

I) explicit cost are those cost that appears on the budget sheet. Explicit cost here includes wage paid to helper , rent , cost of material , investments on equipments which is equal to sum total of 12000+5000+20,000+40,000 =

$77,000

ii) Implicit cost also includes opportunity cost of self owned resources in addition to explicit cost. For example opportunities cost of not choosing the second best career alternative, or opportunity cost of investments .

Here opportunity cost working for own art firm is the next best amount she would have earned which is here 15000 which she would have earned as employee for competitive firm . Alternative investment of 40,000 would have gotten him 4000 per year, which she let go to invest in her firm.

Implicit cost = explicit cost + 4000+15000 = 77000+19000 = 96,0000

iii) fixed cost is the cost of production irrespective of volume of output . There is no marginal aspect of fixed cost, it does not changes with change in quantity of output in short run. Even if zero quantity is produced Rent , helper , investment in equipment has to be incurred. In the above case fixed cost = 12000+5000+40,000 = $57,000

iii) Variable cost changes with the change in volume of production . Material cost is one such cost. Any change in production will require a change in material cost . $20,000 is variable cost