Question

Carol Nice quits her job as a college consultant to start her daycare center. She gave up a salary of $40,000 per year. She also invested her savings of $30,000 (which was earning 5 percent interest) to purchase the equipment needed for the daycare. Please note that the equipment will remain in her business to use for years to come, however she gave up the opportunity of earring 5 percent interest on her saving to open her business. In her first year, Carol spent $18,000 to rent a building for her daycare center, hired a part-time assistant for $12,000 and incurred another $15,000 for expenses related to supplies, utilities, and insurance. Her total revenue for the first year was $80,000. Please discuss the followings. a. Identify the explicit and implicit costs of Carol’s daycare.

Answer 1

Carol Nice's daycare center has explicit costs of $45,000 and implicit costs of $41,500, leading to an accounting profit of $35,000 but an economic loss of $6,500. These figures indicate that while she is profitable by accounting standards, she is not yet economically profitable when considering opportunity costs.

Step-by-step explanation:

When analyzing the costs associated with Carol Nice's decision to start her daycare center, we need to differentiate between explicit and implicit costs.

Explicit costs are the direct, out-of-pocket expenses that are necessary for the operation of her business. In Carol's case, the explicit costs include $18,000 for renting the building, $12,000 for hiring a part-time assistant, and another $15,000 for supplies, utilities, and insurance, leading to a total of $45,000 in explicit costs. Implicit costs, on the other hand, represent the opportunity costs of resources that Carol used in her business but did not pay for directly.

The primary implicit cost is the forgone salary of $40,000 from her previous job and the forgone interest of $1,500 (5% of $30,000) from her savings that she invested in equipment. These implicit costs, totaling $41,500, are the earnings she gave up to pursue her daycare business.

Calculating Carol's accounting profit involves subtracting the explicit costs from her total revenue.

With a revenue of $80,000 and explicit costs of $45,000, her accounting profit would be $35,000. However, to obtain the economic profit, which considers both explicit and implicit costs, we subtract the sum of explicit and implicit costs from the total revenue, resulting in a negative economic profit of $6,500 ($80,000 - $45,000 - $41,500).

This reflects that, while Carol's daycare is profitable in terms of accounting profit, when considering the opportunity costs, it is currently not an economically profitable venture.