Question

2. Economic Cost and Economic Profit

Huang owns a 10-acre blueberry farm. She can farm the land herself, which is expected to bring in $50,000 in revenue and involve $44,000 in operating costs (including planting, fertilizing, and harvesting). Alternatively, she can either rent out the land for $7,000 a year, or sell it at its current market price of $80,000, a price expected to remain the same next year. If she sells it, she expects to be able to obtain a normal rate of return on capital of 7%.

a) What is the opportunity cost of using the land this year to grow blueberries? Considering this, what is Huang’s economic profit from growing blueberries? Should she farm the land?

b) Consider the problem again if the land is expected to go down in value from $80,000 to $78,000, the forecast price for the land next year. What is Huang’s opportunity cost of using the land this year to grow blueberries? What is her economic profit? Should she farm the land?

Answer 1

a.) Opportunity cost is the benefit an individual misses out on while making an economic choice. In the context of this question, the opportunity cost of using the land to grow blueberries by herself is the benefit she would gain from renting out the land and/or selling the land and the rate of return on capital. Therefore, in numerical terms, the opportunity cost here is the rent foregone, which is $7000, plus how much she would gain from selling the land and getting a 7% normal rate of return which is $85600. Concluding, the total opportunity cost of growing blueberries herself is $92600.

Moving on, economic profit/loss is defined as accounting profit/loss minus the opportunity cost. Firstly the accounting profit is, $50000 - $44000 = $6000. Now, to find the economic profit/loss we must subtract the opportunity cost of $92600 from the accounting profit. Therefore, the economic loss here is $6000 - $92600 = - $86600.

Looking at the numeric substantiation she should not farm the land.

b.) The opportunity cost, the economic loss, and the decision of whether she should farm or not would remain the same. As there is a mention of the opportunity cost of growing berries this year.