Question

4 questions

MICROECONOMICS ECONOMIC VS. ACCOUNTING PROFITS - HOMEWORK BSE 2212 2) Chapter 9 #1. Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000 per year if has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3,000 per year. Total annual revenue from pottery sales is $72,000. Calculate the accounting profit and the economic profit for Gomez's pottery firm. 2. The sole proprietor of the "Books and More" bookstore receives all accounting profits earned by her firm and a $28,000-a-year salary she pays herself. She has a standing salary offer of $35,000 a year if she agrees to work for a large corporation. If she had invested her capital outside her own company, she estimates that would have returned $22,000 a year. Last year, her accounting profit was $50,000. What was her economic profit? 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? 4. Suppose Charlie Brown opens a lemonade stand. He hires Linus and Lucy for $12 a week ($6 each). He "rents" pitchers and spoons from his mother for $5 a week and spends $20 a week on paper cups, lemons, sugar, and other materials. Before he opened the stand, he was earning $15 a week selling newspapers. He grosses $72 in revenues a week from lemonade sales. Calculate accounting costs, economic costs, accounting profit, and economic profit. Evaluate how Charlie's lemonade business is doing

Answer 1

Accounting profit is total revenue minus explicit costs.

Explicit costs are those that require monetary outflow like rent, salary,insurance premium

Implicit or opportunity costs do not require actual monetary payments. Implicit costs are opportunity costs. Opportunity cost is the value of the next best alternative.

Economic profit= Accounting profit-implicit costs.

Revenue= $72,000 per year

Explicit costs=

Salary of helper= $12,000 per year

Rent= $5,000 per year

Material= $20,000 per year.

Total explicit costs are =12,000 + $5,000 + $20,000= $37,000.

Accounting profit= $72,000 - $37,000=$35,000.

Implicit costs are

Salary foregone=$15,000 per year

Entrepreneurial talents= $3,000 per year

Interest foregone on own funds invested= $4,000

Total implicit or opportunity costs= $15,000 + $3,000 + $4,000= $22,000

Economic profit= $35,000 - $22,000=$13,000.

2,

Economic profit= Accounting profit-implicit costs.

Implicit costs

Salary foregone= $35,000 - $28,000= $7,000 per year.

Return on own capital foregone= $22,000.

Total implicit costs= $7,000 + $22,000 = $29,000.

Economic profit= $50,000 - $29,000= $21,000.