Question

HANDOUT ABOUT PRODUCTION -CH Z Note: An explicit cost is a cost paid in money. An implicit cost is an opportunity cost incurred by a firm when it uses a factor of production for which it does not make a direct money payment Normal profit is the return to entrepreneurship. The normal profit is part of a firm's opportunity cost because it is the cost of persuading the entrepreneur of not running another business. Chapter 7 Handout. Question 2: In 2013, Roma was a schoolteacher and earned $40,000. But she enjoys creating cartoons, so at the beginning of 2014, Roma quit teaching and set to work as a cartoonist. She stopped renting out her basement for $5,000 a year and began to use it as her office. She used $5,000 from her savings account to buy a new computer, and she leased a printer for $150 a year. During 2014, Roma paid $1,250 for paper, utilities, and postage; the bank paid 5 percent a year on savings account balances; and Roma sold $50,000 of cartoons. At the end of 2014, Roma was offered $4,000 for her computer. For 2014, calculate Roma's: a. Calculate Accounting costs (total Explicit costs). b. Calculate Accounting Profit Accounting Profit - Total Revenue - Accounting Cost c. Calculate Implicit costs. Hint: Do not forget to include the economic depreciation on the computer, wage forgone, rent forgone, Interest payments forgone t 24

Answer 1

a. Accounting costs are explicit cost for which direct money payment is made. These are the costs on factors hired or purchased.

Cost of computer=$5,000

Lease on printer= $150

Paper, utilities and postage=$1250

Total accounting cost= 6400.

b. Accounting profit is the difference between the total revenue and explicit cost (accounting cost). In other words total revenue – total accounting cost.

Total revenue = $50,000(money from the sale of cartoons)

Total accounting cost= $6400

Then accounting profit= $50,000-$6400=$43,600.

c. Implicit costs are imputed costs on self owned factors or services of an entrepreneur for which no direct money payment is made.

The opportunity cost of self owned service as a cartoonist= $40,000

Rent on her basement= $5,000

5% interest on deposit of $5,000=$250.

Depreciation of computer= $1000

Total implicit cost=$46250.

d. Economic cost is the sum of implicit cost and explicit cost.

Economic cost= $6400+$46250=$52650

e) Economic profit= Total revenue –total implicit cost and explicit cost.

Economic profit= $50,000-$52650(implicit cost:$46250, explicit cost$6400)=$−2650.

Economic profit= $−2650.

f. While calculating the economic profit the firm takes in to consideration both explicit cost and implicit cost.   But for the calculation of accounting profit only explicit costs are considered. A company’s accounting profit is total revenue minus explicit cost. It is the difference between cash paid and cash received. But a company’s economic profit is the difference between the total cost and the total revenue. The total cost includes both explicit cost and implicit costs. In short the calculation of accounting profit includes only explicit cost, the economic profit includes explicit cost and implicit cost.