Question

4. For $5,000 paid in advance Larry leased (rented) a set of old seaside cabins to then rent out in turn to vacationers during the summer. His lease was from June 1 to Sept. 30 or for 13 weeks but his plan was to operate the business for the first 10 weeks only. His costs and revenue are shown below. Costs and Revenue - Based on paying for the 13 week lease but only operating the sub-rental business for 10 weeks Lease for the summer (13 weeks), paid fully in advance $5,000 Signs & Advertising (one-time cost fully paid in June) 500 Repairs (cash expenses incurred and paid prior to opening) 3,000 Insurance (required for the full 13 week lease period, paid in advance) 2,000 Power and supplies at $180 per week (10 x $180 per week) 1.800 Larry's forgone earnings (summer job not taken 10 x S520 per week) 5.200 Revenue (over 10 weeks of operations) $16,500 (a) Calculate Larry's explicit costs and accounting profit. (b) What are Larry's implicit costs and total economic costs? (c) What is Larry's economic profit after operating the business for 10 weeks? (d) Larry's has to go back to school after 10 weeks but his lease runs for another 3 weeks. He can hire Daryl for $520 per week to operate the cabins but demand in September is weak. If he expects revenue to be $800 per week should he hire Daryl and operate for the extra 3 weeks until the lease expires? Why or why not? Continued on back (e) If he hires Daryl and operates the business over the final 3 weeks of the lease (and revenue does average $800 per week) what will then be his economic profit for the summer? Cont. (f) If Larry has the opportunity to lease the cabins next year for $5,000 and there is no reason to expect changes in his revenue or costs is he likely to do so? Why or why not?

Answer 1

a) Explicit costs are the ones which could be seen ie are a part of balance sheet.

Explicit costs are = lease + advertising+ repair + insurance+ power

=$5000+3000+500+2000+1800= 12300

His accounting profit = revenue- cost

=$ 16500-12300

=$ 4200

b) Implicit costs would include the opportunity costs as well

So implicit cost = cost of foregoing summer job

Total economic costs = explicit+ implicit cost

= $ 12300+5200=17500

c)Economic profit= revenue- total economic costs

$ 16500-17500=$(-)1000

d) Hiring Daryl would mean a cost of $520*3=$1560 and a revenue of $800*3=$2400

The profit would be =$2400-1560=$840

So even if his economic profit would have not been equal to zero, still his accounting profit would increase with this.

It would be now=$4200+840=$5040