Question

Florence is considering going into business for herself and has developed the following estimates of monthly costs and revenues to aid her in her decision-making process. She has decided to house the business in a building that she already owns, although she could rent the building to someone else for $1,000 per month. Estimated payments for utilities (electricity, natural gas, water, and telephone) are $475 per month. She will hire one employee at a total cost of $1,100 per month. Inventory is estimated to cost $2,800 per month. Finally, Florence earns $3,000 a month in her current job. (show your calculations)

a) How much monthly revenue would Florence have to take in to earn zero economic profit?

b) Assume that Florence has estimated her monthly revenue to be $9,000. In this case, Florence would earn an accounting profit (loss) of ________, and an economic profit (loss) of ________.

c) Assume instead that Florence does not own a building, and that she will have to rent a building for $1,000 per month (all other estimates remain the same). In this case (assuming estimated monthly revenue is still $9,000), Florence would earn an accounting profit (loss) of ________, and an economic profit (loss) of ________.

Answer 1

Accounting profit is total revenue minus explicit costs. Explicit costs are those that require monetary payments like rent, salary, repairs etc.

Economic profit is total revenue minus (explicit costs + implicit costs). Implicit costs do not require actual monetary payments. Implicit costs are opportunity costs. Opportunity cost is the value of the next best alternative.

Implicit cost= Rent + Salary foregone= $1,000+$3,000=$4,000.

Explicit cost= Utilities + salary+ inventory= $475 + $1,100 + $2,800=$4,375.

1. Implicit + explicit costs= $4,000 + $4,375=$8,375. Florence would have to make $8,375 per month to earn zero economic profits.

2. Accounting profit= $9,000-$4,375=$4,625.

Economic profit= $9,000 –($4,375+ $4,000)=$625

3. If Florence rents the building, then implicit costs will go down by $1,000, which will be $3,000.

Explicit costs will go up by $1,000, which will be $5,375.

Account profit will be $9,000 - $5,375=$3,625.

Economic profit= $9,000 –($5,375+ $3,000)=$625.