Question

Joe quits his computer programming​ job, where he was earning a salary of ​$50 comma 000 per​ year, to start his own computer software business in a building that he owns and was previously renting out for ​$30,000 per year. In his first year of business he has the following​ expenses: salary paid to​ himself, ​$47,500​; ​rent, $0; and other​ expenses, ​$25,000. Find the accounting cost and the economic cost associated with​ Joe's computer software business. The accounting cost of​ Joe's business is? The economic cost of​ Joe's business is ?

Answer 1

Solution:

Calculation of Accounting Cost of Joe's Business:

Accounting costs are those costs that are actually incurred by Joe.

Accounting costs do not include opportunity costs.

Thus the Accounting costs of Joe’s business are Salary paid to himself and other expenses actually incurred.

As per the information given in the question we have

Salary paid to himself = $ 47,500 ; Other expenses = $ 25,000

Thus the Accounting cost of Joe’s business = Salary paid to himself + Other expenses

= $ 47,500 + $ 25,000

= $ 72,500

Thus the Total Accounting cost of Joe’s Business = $ 72,500

Calculation of Economic Costs of Joe's Business:

Economic costs are actual cost incurred plus opportunity cost.

As per the information given in the question,

1.Joe is using his own building that he used to previously rent out for $ 30,000, for his software business. Thus he will no longer receive the same as he is using the building for his own business. Thus the opportunity cost here is = $ 30,000

2.Joe’s salary from his own business is lesser than the amount he was receiving on his job.

Thus Opportunity cost = Salary from Job – Salary from Business

= $ 50,000 - $ 47,500

= $ 2,500

Thus the Economic cost of Joe’s Business = Salary paid to himself + Other expenses + Opportunity cost of building rent + Reduction in salary from business

= $ 47,500 + $ 25,000 + 30,000 + 2,500

= $ 105,000

The Economic cost of Joe’s Business = $ 105,000