Question

John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense Amount $2,000 500 Tabor - Food and drink Electricity Vehicle lease Rent Interest on loan for equipment 100 150 500 1.000 a. Calculate John's annual accounting profit. $ . b. Suppose John could earn $1,000 per year as a recycler of aluminum cans, but he prefers to run the café. In fact, he would be willing to pay up to $275 per year to run the café rather than to recycle. Is the café making an economic profit? of $ per year. Click to select) , the café is making an economic (Click to select) Should John stay in the cafe business? (Click to select) c. Suppose the café's revenues and expenses remain the same, but recyclers' earnings rise to $1,100 per year. Is the café making an economic profit? Click to select) the café is making an economic (Click to select) of $ per year. Should John stay in the café business? Click to select) d. Suppose John had not had to get a $10,000 loan at an annual interest rate of 10 percent to buy equipment, but instead had invested $10,000 of his own money in equipment Calculate John's annual accounting profit. $ e. As in part b, suppose John could earn $1,000 per year as a recycler and he has to pay $1,000 per year in interest on his loan, but, unlike part b, suppose John likes recycling just as well as running the café. How much additional revenue would the café have to collect each year to earn a normal profit? $C .

Answer 1

a) John’s accounting profit: $750

Working: Total explicit cost = [Labour + Food and drink + Electricity + Vehicle lease + Rent + Interest on loan for equipment] = $4250

Revenue - Explicit costs = $5,000 - $4,250 = $750

b) Economic profit; $25 per year; John should stay in the cafe business

Working: Opportunity cost for running cafe = ($1,000 - $275) = $725 per year

Economic profit = [$5,000 - $4,250 - $725] = $25 per year

As John is earning economic profit thus should stay in business

c) Economic loss; $75 per year; John should not stay in the cafe business

Working: Opportunity cost for running cafe = $1,100 - $275 = $825 per year

Economic loss = [$5,000 - $4,250 - $825] = $75 per year

As John is earning economic loss thus should not stay in business

d) John’s accounting profit: $1750

Working: Total explicit cost = [Labour + Food and drink + Electricity + Vehicle lease + Rent] = $3250

Revenue - Explicit costs = $5,000 - $3,250 = $1750

e) Solution: Normal profit = $250

Working: Opportunity cost = $1000

Total explicit cost = [Labour + Food and drink + Electricity + Vehicle lease + Rent + Interest on loan for equipment] = $4250

Revenue - Explicit costs = $5,000 - $4,250 = $750

Normal profit = $1000 - $750 = $250