Question

Charles lives in Philadelphia and runs a business that sells guitars. In an average year, he receives $704,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $404,000; he also pays wages and utility bills totaling $286,000. He owns his showroom; if he chooses to rent it out, he will receive $3,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Charles does not operate this guitar business, he can work as an accountant, receive an annual salary of $20,000 with no additional monetary costs, and rent out his showroom at the $3,000 per year rate. No other costs are incurred in running this guitar business. Identify each of Charles'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 Charles pays the manufacturer The wages and utility bills that Charles pays The salary Charles could earn if he worked as an accountant The rental income Charles could receive if he chose to rent out his showroom Complete the following table by determining Charles's accounting and economic profit of his guitar business. Profit (Dollars) Accounting Profit Economic Profit

Answer 1

The difference between the accounting profit and the economic profit is that , when calculating the accounting profit the explicit costs are only considered and the implicit costs are ignored. The explicit costs are the direct costs that is paid out of the pocket and the implicit costs are some kind of opportunity costs. While calculating the economic profit both the explicit as well as the implicit costs are added.

Accounting profit= Total revenue- explicit costs.

Economic profits= Total revenue- explicit+implicit costs.

Accounting profit =704,000-690,000 (404,000+286,000)

= 14000

Economic profit = 704,000- 713000(404,000+286,000+20,000+3000)

= -9000.