Question

During a year of operation, a firm collects $5,100,000 in revenue and spends $3,600,000 on labor expenses, raw materials, rent, and utilities. The firm's owner has provided $1,000,000 of her own money instead of investing the money and earning a 12% annual rate of return. a. The explicit costs of the firm are $______. The implicit costs are $______. The total economic cost is $_____.

b. The firm earns accounting profit of $____.

c. The firm's economic profit is $_____.

d. If the owner could earn 15% annually on the money she has invested in the firm, the economic profit of the firm would be _____ (when revenue is $5,000,000.)

Answer 1

A)

The explicit cost is the out of pocket cost incurred by a firm.

Total Revenue of the firm =$5,100,000

Expenditure on labor expense, rents, utility and raw materials =$3,600,000

Since Expenditure on labor expense, rents, utility and raw materials are payments to outsiders for the production so it is explicit cost.

Total imputed rent of $1,000,000 at the rate of 12% p.a. = 12% of $1,000,000

= 1,000,000*12/100

= $120,000

Since Total imputed rent of $1,000,000 at the rate of 12% p.a. are lost due to hiring this capital for his firms, so it is an implicit cost.

Total economic cost will be sum of explicit cost and implicit cost = $3,600,000 + $120,000

=$3,720,000

B)

Accounting profit = TR - total explicit cost

Accounting profit = $5,100,000 - $3,600,000

= $1,500,000

(C)

Economic profit = TR - (explicit cost + implicit cost)

Economic profit = $5,100,000 - $3,720,000

=$1,380,000

(D)

If firm could earn 15% p.a. interest on the invested money $1000,000, then total imputed rent or implicit cost will be

= 15% of 1,000,000

=1,000,000* 15/100

=$150,000

New Economic profit = TR - (explicit cost + implicit cost)

= $5,000,000 - (3,600,000 +150,000)

= $5,000,000 - 3,750,000

=$1,250,000

New Economic profit of the firm will be $1,250,000.