Question

Sally quit her job as an auto mechanic earning $50,000 per year to start her own business. To save money she operates her business out of a small building she owns which, until she started her own business, she had rented out for $10,000 per year. She also invested her $20,000 savings (which earned a market interest rate of 5% per year) in her business. You are given the following information about the first year of her operations.

Cost of labor 40,000

Cost of materials 15,000

Equipment rental 5,000

a. Calculate her explicit costs.

b. Calculate her implicit costs.

Answer 1

Sally's explicit costs, which consist of labor, materials, and equipment rental, total $60,000. Her implicit costs, which incorporate the foregone rent and interest from savings, amount to $11,000. Together, these calculations help us understand the financial implications of Sally's decision to transition from mechanic to business owner.

Step-by-step explanation:

Calculating Explicit and Implicit Costs

When Sally quits her job as an auto mechanic earning $50,000 per year and starts her own business, she incurs several types of costs. The question requires us to calculate two types of costs: explicit and implicit.

Explicit Costs

Sally's explicit costs are the direct, out-of-pocket expenses for her business, including the following:

• Cost of labor: $40,000
• Cost of materials: $15,000
• Equipment rental: $5,000

Adding these up, Sally's total explicit costs for the business amount to $60,000 per year.

Implicit Costs

Implicit costs are the opportunity costs of resources that Sally already owns or the income she forgoes to pursue her business venture. These include the annual rent from the small building and the foregone interest from her savings. Here's a breakdown:

• Annual building rent foregone: $10,000
• Foregone interest on savings: $20,000 * 5% = $1,000
• Therefore, the total implicit costs are $11,000.