Question

Suppose a firm has an annual budget of $200,000 in wages and salaries, $75,000 in materials, $30,000 in new equipment, $20,000 in rented property, and $35,000 in interest costs on capital. The owner/manager does not choose to pay himself, but he could receive income of $90,000 by working elsewhere. The firm earns revenues of $360,000 per year.

Required:
a) what are the annual explicit costs for the firm described above?
b) what are the annual implicit costs for the firm described above?
c) what are the annual economic costs for the firm described above?
d) what is the accounting profit for the firm described above?
e) what is the economic profit for the firm described above?

Answer 1

Answer and Explanation:

The computations are shown below

a. For Annual explicit cost

= Wages and salaries + material cost + new equipment cost + rental property + interest cost in capital

= $200,000 + $75,000 + $30,000 + $20,000 + $35,000

= $360,000

We considered all the cost which are incurred with respect to material, wages and salaries, equipment, etc

b. For Annual implicit cost

= Income received

= $90,000

= $90,000

It includes the opportunity cost which could be earned by the individual or company

c. For annual economic cost

= Explicit cost + Implicit cost

= $360,000 + $90,000

= $450,000

It is a mix of both explicit cost and the implicit cost

d. For accounting profit

As we know that

Accounting profit = Total revenues - explicit costs + depreciation.

= $360,000 - $360,000

= $0

e. For economic Profit it is

= Total Revenues – Explicit Costs – Implicit Costs

= $360,000 - $360,000 - $90,000

= -$90,000