Question

[3] Suppose your aunt has just closed her books from her first year in the retail cookie business and is ecstatic with the profit her accountant says she has earned. Her business earned $115,000 in sales revenue over the year, and its costs for rent, raw materials, electricity, and the like were $80,000. Your uncle is not quite as elated, but can't figure out exactly why. In discussing the situation with you (the family economist), he offers the following information. Your aunt gave up her job, which was paying her $22,000 a year, at a local corporation. Your uncle worked in the store every evening and most weekends - giving up the opportunity to take on additional clients or to work overtime. In addition to being tired, he figures that he lost $15,000 in additional income. What was your aunt and uncle's accounting profit? What was your aunt and uncle's economic cost of production? What is their economic profit? Would you recommend that they keep the cookie business running for next year?

Answer 1

Sales revenue = 115,000

Cost for rent, raw materials, electricity and others = 80,000

These costs are called as accounting or explicit cost. The costs that paid to outsiders and other factors of production.

Aunt used to work in a local corporation. She gave up the work where she was getting 22,000

Your auncle too is loosing additional income of 15,000 by working in the store every evening.

So your uncle and aunts opportunity costs that lost by starting the business is 37,000 (22,000+15,000)

This called as implicit cost. The benefit of own investment and own services that is sacrificed.

a. What accounting profit?

Accounting profit = Total Revenue – Accounting Cost

Accounting profit = 115,000 – 80,000 = 35,000

b. Economic Cost

Economic Cost = Accounting Cost + Implicit Cost

Economic Cost = 80,000 + 37,000 = 117,000

c. What is economic Profit

Economic Profit = Total Revenue – Economic Cost

Economic Profit = 115,000 – 117,000 = (2,000)

There is an economic loss of 2,000

d. What would you recommend?

The recommendation is that they should NOT continure the business for the next year. As they are not able to recover the implicit cost, they should not continue the business for the next year.