During a year of operation, a firm collects $300,000 in revenue and spends $200,

Question

During a year of operation, a firm collects $300,000 in revenue and spends $200,000 on labor expense, raw materials, rent, and utilities. The firm’s owner has provided $750,000 of her own money instead of investing the money and earning a 10% annual rate of return.

a. How much are the explicit (accounting) costs, the implicit costs, and the total economic costs?

b. How much are the firm’s accounting profit and economic profit?

c. If the owner was working for a full-time job with annual salary of $30,000 before she quit the job to operate the business, do you think she made the right decision from the perspective of long-run economic profit? Please explain your answer briefly.

Explanation / Answer

a) The explicit costs include just the $200000 that the owner spends on labor. The implicit costs include the opportunity costs i.e the $75000 income of 10% that the owner would have earned if he would have invested the $750000. The total economic costs include the explicit and the implicit costs which total up to $275000.

b) The accounting profit is the explicit revenues less explicit costs which are equal to $300000 - $200000 = $100000. The economic profit is the total revenues less total costs which is equal to $300000 - $275000 = $25000.

c) If the owner had a salary of $30000, the implicit costs and thus total costs would increase by $30000. So, total costs will become $305000 and with a revenue of $300000, she would make an economic loss. Thus, her decision to quit the job to operate her business was incorrect from the perspectivee of long - run economic profit.

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