Question

Teresa has a shoe factory. She owns the building that the factory is in. If she rented it out rather than using it to produce shoes she could get $50,000 per year in rent. Teresa has labour costs of $300,000 per year and raw materials cost her $200,000 per year. She pays $15,000 in advertising each year. If Teresa was not producing shoes she could work as a manager at the Nike factory and make $100,000 per year. Teresa used up her savings to start the shoe factory forgoing $20,000 in interest.

A. What are the explicit costs of this factory?
B. What are the implicit costs?
C. If Teresa has a total revenue of $590,000, what is the accounting profit?
D. If Teresa has a total revenue of $590,000, what is the economic profit?
E. If Teresa was a rational producer, should she continue producing shoes? Why or why not?

Answer 1

A.

Explicit costs = $515000

B.

Implicit cost = $170000

C.

Accounting Profit = $75000

D.

Economic Profit = - $95000

E.

A rational producer will base his/her decision on the economic profit of a decision and consider the opportunity costs. Thus, as operating the factory has a negative economic profit (or economic loss) of $95000, as a rational producer, Teresa should stop producing shoes.

Step-by-step explanation:

A.

Explicit costs are the costs that are directly involved and incurred as a result and results in an outflow of cash from the entity.

Explicit costs = 300000 + 200000 + 15000

Explicit costs = $515000

B.

Implicit costs are the costs that does not require an outflow of cash from the entity. These are the opportunity costs of an entity's decision in terms of what the entity has to give up.

implicit cost = 50000 + 100000 + 20000

Implicit cost = $170000

C.

The accounting profit is the profit calculated by deducting the explicit costs of the business from the total revenue. This is normally the profit which is calculated and recorded by all the businesses under GAAP and IFRS.

Accounting Profit = Total Revenue - Explicit costs

Accounting profit = 590000 - 515000

Accounting profit = $75000

D.

Economic Profit is calculated by deducting all the costs, both explicit and implicit, from the total revenue.

Economic Profit = Total Revenue - Explicit costs - Implicit costs

Economic Profit = 590000 - 515000 - 170000

Economic Profit = - $95000

E.

A rational producer will base his/her decision on the economic profit of a decision and consider the opportunity costs. Thus, as operating the factory has a negative economic profit (or economic loss) of $95000, as a rational producer, Teresa should stop producing shoes.