In: Economics
1. Suppose Andre operates a local beet farm (Beets by Dre) and has the following financial information (per year): total revenues from sales are $800,000, labor costs are $450,000, equipment costs are $150,000, materials are $120,000, and utilities are $7,000. Andre owns the land and could lease it out for $60,000 per year if he wasn’t using it to run his own business. Andre has a standing offer to go to work for his brother at his crystal shop (The People’s Quartz) at a salary of $35,000 per year. If he worked for his brother, he would also have time to pursue his passion of knitting sweaters for dogs and selling them on the dog show circuit. This would bring in another $3,000 per year. Andre will not have time for his sweater business or to work for his brother if he is operating his farm.
a. (3 points) Calculate both the accounting and economic profits from running Beets by Dre. (NOTE: You need to show your calculations to receive full credit)
b. (2 points) Based on the calculations in part a, what should Andre choose to do? Explain briefly. Give a practical interpretation of the economic profit number as if explaining to a friend that has not taken economics (or has taken it at BSU).
Revenue = 800000
Labor cost = 450000
Equipment cost = 150000
Material cost = 120000, utilities = 7000
Standing offer of job = 35000
Lease payment = 60000
Sale of sweater = 3000
Explicit cost = Labor cost + equipment cost + material cost + utilities
= 450000 + 150000 + 120000 + 7000 = 727000
Implicit cost = 60000 + 35000 + 3000 = 98000
Accounting profit = Total revenue - Explicit cost = 800000 - 727000 = 73000
Economic profit = Total revenue - Explicit cost - Implicit cost = 800000 - 727000 - 98000 = -25000
Andre should go to work for his brother, as in doing so Andre will earn an economic profit of 98000 vs a loss of -25000
Economic profit is obtained by subtracting the opportunity cost of doing any activity from the accounting profit
Suppose Andre goes to work for his brother then he will earn 35000 salary, 60000 from the lease and 3000 from sweater sale
This was the opportunity cost of doing Beef business. He can earn 98000 without doin business, but he earns 73000 with doing business so he is earning a negative economic profit.