Question

ou are currently a worker earning $60,000 per year but are considering becoming an entrepreneur. You will not switch unless you earn an accounting profit that is on average at least as great as your current salary. You look into opening a small grocery store. Suppose that the store has annual costs of $150,000 for labor, $50,000 for rent, and $30,000 for equipment. There is a one-half probability that revenues will be $200,000 and a one-half probability that revenues will be $410,000.

Instructions: For all parts, enter a loss as a negative number. If you are entering any negative numbers be sure to include a negative sign (-) in front of those numbers.

a. In the low-revenue situation, what will your accounting profit or loss be?

In the high-revenue situation, what will your accounting profit or loss be?

b. On average, how much do you expect your revenue to be?

Your accounting profit?

Your economic profit?

Will you quit your job and try your hand at being an entrepreneur?

   (Click to select)  No  Yes

c. Suppose the government imposes a 25 percent tax on accounting profits. This tax is only levied if a firm is earning positive accounting profits. What will your after-tax accounting profit be in the low-revenue case?

In the high-revenue case?

What will your average after-tax accounting profit be?

What about your average after-tax economic profit?

Will you now want to quit your job and try your hand at being an entrepreneur?

   (Click to select)  No  Yes

d. Other things equal, does the imposition of the 25 percent profit tax increase or decrease the supply of entrepreneurship in the economy?

   (Click to select)  Decrease  Increase

Answer 1

earning $60,000 per year but are considering becoming an entrepreneur. You will not switch unless you earn an accounting profit that is on average at least as great as your current salary. You look into opening a small grocery store. Suppose that the store has annual costs of $150,000 for labor, $50,000 for rent, and $30,000 for equipment. There is a one-half probability that revenues will be $200,000 and a one-half probability that revenues will be $410,000.

1) Explicit costs : $230,000 ( = $150,000 + $50,000 + $30,000)

Accounting profits in the lower-revenue case: $200,000 - $230,000 = -$30,000

Accounting profits in the high-revenue case: $410,000 - $230,000 = $180,000

　

2) On average, revenues will be $305,000 per year (= 0.5X$410,000 + 0.5X$200,000).

　

On average, accounting profits will equal $75,000 per year (= $305,000 in average revenue - $230,000 in explicit costs)

　

On average economic profits will equal $15,000 per year (= $75,000 of average accounting profits - $60,000 opportunity costs of foregone wages).

　

You WILL perfer quiting the job to become an entrepreneur

3) In low-revenue scenario the after-tax accounting profit will remain same because firm is suffering a loss of - $30,000 and the tax will be applicable if the firm is making a profit.

In the high-revenue scenario the after-tax accounting profit will equal $135,000 (= 0.75 X $180,000).

Average after-tax accounting profit will equal $52,500 (= 0.5X[-$30,000] + 0.5X$135,000).

Average after-tax economic profit will equal - $7,500 (= $52,500 - $60,000).

You WILL NOT perfer quiting the job to become an entrepreneur

　

4) The profit tax will reduce the entrepreneurship supply in the economy