Question

You own and are the only employee of a company that sells custom embroidered pet sweaters. Last year your total revenue was $120,000. Your costs for equipment, rent, and supplies were $30,000. To start this business, you invested an amount of your own capital that could pay you a $50,000 a year return. Calculate the economic cost, normal rate of return, accoynting profit and economic profit. 3) What is the relationship between average total cost and marginal cost? 4) What is the difference between accounting cost and economic cost? 5) Define the normal rate of return. If a business has steady revenues and the future looks secure, what should the normal rate of return equal? Why?

Answer 1

Answer : Economic Cost = $80.000

Normal Rate of return = 300 %

Economic Profit = $40, 000

Accounting Profit = $90,000

Step-by-step explanation

Total Revenue = $1,20000

Total Cost = $30,000 +$50,000

Oppotunity cost is included in Economic Cost.

Hence EC (Economic Cost) = 30,000+50,000

= $80,000

Normal Rate of return = (1,20000 - 30,000)/ 30,000

= 300 %

Accounting Profit = Total Revenue - Explicit cost

= $120,000 -$30,000

= $90,000

Economic Profit = $120,000 -$30,000 - $50,000

= $40, 000

Relationship between Average Total Cost (ATC) and Marginal Cost (MC)

When MC falls, ATC also falls but rate of fall is higher in ATC.

ATC cuts MC where ATC is minimum.

Answer 2

1) total revenue = $120,000

yearly costs = $30,000

opportunity costs of investment = $50,000

• economic costs include both accounting and opportunity costs = $30,000 + $50,000 = $80,000
• normal rate of return = accounting profit / investment* we are not given the investment amount, only the returns that the investment could yield, so we cannot calculate the normal rate of return
• accounting profit = $120,000 - $30,000 = $90,000
• economic profit = $120,000 - $30,000 - $50,000 = $40,000

3) When average total cost increases, that means that the marginal cost must be greater than the average total cost. If the addition of another unit of output does not change average total cost, it means marginal cost = average total cost.

4) Accounting costs only include explicit expenses (e.g. materials, utilities, labor, etc.), while economic costs include implicit or opportunity costs. Opportunity costs are the extra costs or benefits lost from choosing one activity or investment from another alternative.

5) The normal rate of return is how much profits does a specific investment yield (in percentage). There is no absolute good or bad rate of return. For example, risky investments that yield 15% per year are considered good investments, but some secure investments that yield 5-10% can also be considered good investments that yield high rates of return. investors are risk averse, so the riskier the investment, the higher the return they will expect form it.