Question

1. Definition of economic costs Lorenzo lives in Philadelphia and runs a business that sells guitars. In an average year, he receives $701,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $420,000; he also pays wages and utility bills totaling $247,000. He owns his showroom; if he chooses to rent it out, he will receive $9,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Lorenzo does not operate this guitar business, he can work as a financial advisor, receive an annual salary of $32,000 with no additional monetary costs, and rent out his showroom at the $9,000 per year rate. No other costs are incurred in running this guitar business. Identify each of Lorenzo's costs in the following table as either an implicit cost or an explicit cost of selling guitars. Implicit Cost Explicit Cost The salary Lorenzo could eam if he worked as a financial advisor The wholesale cost for the guitars that Lorenzo pays the manufacturer The wages and utility bills that Lorenzo pays The rental income Lorenzo could receive if he chose to rent out his showroom

Answer 1

Implicit cost is the one for which there is no explicit payment made to the supplier of the service. Explicit cost on the other side is the cost which is added in the accounting books and for which there is an explicit payment made

• the salary that could have been earned as financial advisor would be considered as a lost opportunity and it is an implicit cost
• Wholesale cost is incurred and the payment is made to the manufacturer which means it is an explicit cost
• wages and utility bills are also a part of explicit cost
• parental income is also a lost opportunity to earn because it could have been earned, hence it is an implicit cost.