Question

William Howe must decide whether to start a business renting beach umbrellas at an ocean resort during June, July, and August of next sum­mer. He believes that he can rent each umbrella to vacationers at $7 a day, and he intends to lease 40 umbrellas for the three-month period for $4,000. To operate this business, he does not have to hire anyone (but himself), and he has no expenses other than the leasing costs and a fee of $3,000 per month to rent the location of the business. Howe is a college student, and if he did not operate this business, he could earn $5,000 for the three-month period doing construction work. If there are 80 days during the summer when beach umbrellas are demanded, and if Howe rents all 40 of his umbrellas on each of these days, how much is his total revenue?

b.Using the information in question #1, what will be William Howe’s explicit and implicit cost for the summer?

c.Using the information in question #1, what will be William Howe’s accounting profit for the summer?

d.Using the information in question #1, what will be William Howe’s economic profit for the summer?

Answer 1

a. Total Revenue(TR) = Price x Quantity

So, TR = (80 days) x($7) x (40 umbrellas) = $ 22400

b.

Explicit Costs = (3 months) x ($3000 per month rent) + ($4000 umbrella lease)

                     = $9000 + $4000

                     = $13000

Implicit Costs are input costs that do not require an outlay of money by firm or individual.They can be calculated by considering oppurtunity cost.

In this case, the oppurtunity cost is $5000 for the three-month period that can be earned by doing construction work.

Implicit Costs = $5000

c. Accounting Profit = Total Revenue - Explicit Costs

So, Howe's accounting profit this summer will be:

Accounting Profit = $22400 - $13000 = $9400

d. Economic Profit = Total Revenue - Explicit Costs -Implicit Costs

So, Howe's economic profit this summer will be:

Economic Profit = $22400 - $13000 -$5000 = $4400