Question

Raphael lives in New York City and runs a business that sells guitars. In an average year, he receives $735,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $435,000; he also pays wages and utility bills totaling $255,000. He owns his showroom; if he chooses to rent it out, he will receive $10,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Raphael does not operate this guitar business, he can work as an accountant and receive an annual salary of $24,000 with no additional monetary costs. No other costs are incurred in running this guitar business.

Identify each of Felix’s costs in the following table as either an implicit cost or an explicit cost of selling guitars.
Implicit Cost Explicit Cost
The wholesale cost for the guitars that Felix pays the manufacturer
The rental income Felix could receive if he chose to rent out his showroom
The salary Felix could earn if he worked as a paralegal
The wages and utility bills that Felix pays
Complete the following table by determining Felix’s accounting and economic profit of his guitar business.
Profit
(Dollars)
Accounting Profit
Economic Profit

Answer 1

Explicit cost

The wages and utility bills that Felix pays

The wholesale cost for the guitars that Felix pays the manufacturer

Implicit cost

The rental income Felix could receive if he chose to rent out his showroom

The salary Felix could earn if he worked as a paralegal

Accounting profit = $45,000

Economic profit = $11,000

Step-by-step explanation:

Implicit cost also known as opportunity cost is the cost of the next best option forgone when one option is chosen over another option.

When Felix decides to open a guitar shop, he would be forgoing the opportunity of working as a paralegal.

Also, he would be forgoing the opportunity of earning rental income from his showroom.

Explicit cost is the actual cost incurred

Accounting profit = Revenue - Total Explicit Costs

Total Explicit Costs = $435,000 + $255,000 = $690,000

$735,000 - $690,000 = $45,000

Economic profit = Accounting profit - Implicit cost

Total implicit costs = $24,000 + $10,000 = $34,000

$45,000 - $34,000 = $11,000