Question

Betty is considering operating her own tutorial school. Below is the information for the coming ear if she goes ahead to run the school.

The total after-tax revenue of her tutorial school in the coming year is $800,000.

Betty has to use her own property for running the school. She has to give up the annual rental income of $85,0000 in the coming year.

She has to borrow $50,000 at a 3% interest rate from a bank in the coming year.

Betty will not supply labour service to her tutorial school business. Instead, she will continue to work as an accountant in firm X and earn $65,00 annually in the coming year. She will employ three teachers to work in the tutorial school and pay them totally $95,000 in the coming year.

She has to spend $250,000 to purchase furniture and the market value will decrease by 20% in the coming year. Her accountant mentions the annual depreciation for this school will be $7,500 in the coming year.

Instead of operating a tutorial school, she could operate a fast food shop and make an annual profit of $38,000 in the coming year.

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(a) What is the explicit cost of Betty's tutorial school in the coming year? Show all the steps of calculation.

(b) What is the implicit cost (including econ mic deprecation) of Betty's tutorial school in the coming year? Show all the steps of calculation.

(c) Based on your answers in (a) and (b), what is the economic profit of Betty's tutorial school in the coming year? Show all the steps of calculation.

Answer 1

The explicit costs of Betty's tutorial school include the rental income given up, interest on a loan, total teacher salaries, and the purchase of furniture. The implicit costs include the opportunity cost of Betty's annual salary and economic depreciation of furniture. The economic profit can be calculated by subtracting both explicit and implicit costs from the total after-tax revenue.

Step-by-step explanation:

(a) The explicit costs of Betty's tutorial school in the coming year can be calculated as follows:

• Annual rental income given up: $85,000
• Interest on loan: $50,000 * 3% = $1,500
• Total salary paid to teachers: $95,000
• Purchase of furniture: $250,000

(b) The implicit costs of Betty's tutorial school in the coming year can be calculated as follows:

• Opportunity cost of Betty's annual salary as an accountant: $65,000
• Economic depreciation of furniture: $7,500

(c) To calculate the economic profit, we need to subtract both the explicit and implicit costs from the total after-tax revenue:

Economic profit = Total after-tax revenue - Explicit costs - Implicit costs

Economic profit = $800,000 - ($85,000 + $1,500 + $95,000 + $250,000) - ($65,000 + $7,500)