5. Suppose an accounting firm has revenues of $60,000. Below is a list of costs

Question

5. Suppose an accounting firm has revenues of $60,000. Below is a list of costs that firm incurred. (These are ALL costs.)

1. Raw materials $20,000
2. Rent that could have been earned $10,000
3. Interest on savings that was used to start the business $8,000
4. Clerical assistance (part-time) $6,000
5. Profits from a tax business $10,000

a. Calculate accounting profit and economic profit.
b. Does it make sense for this firm to continue operating in the short run? Why or why not?
c. Does it make sense for this firm to continue operating in the long run? Why or why not?

Explanation / Answer

total revenue = $60000

explicit cost= Raw materials $20,000

accounting profit. = 60000-20000=40000

Implicit cost
2. Rent that could have been earned + Interest on savings that was used to start the business + Clerical assistance (part-time + Profits from a tax business

= $10,000 + $8,000 +$6,000 + $10,000 = 34000

economic profit = 40000-34000=6000

b) If the price falls below average variable cost, then it would be better for the firm to shut down the production in the short run as the firm would not be able to cover the variable cost so it is better to shut down the production otherwise it can operation continuously when P> ATC ( profit maximization) and ATC> P> AVC ( loss minimization)

c) in the long run firm earn zero economic profit due to entry and exit of several firms as they only cover ATC equal to price so it is upto firm stay and exit of the market. it can operate and go out of the market,

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