Question

46. Assume that you have taken 12 months' leave without pay from your full-time job as a dressmaker and set up a business ironing and repairing clothes. You have taken out a 12-month lease on a small shopfront in a suburban shopping centre. You have bought all the equipment you need for your business and arranged the fit-out of your premises to accommodate your work requirements. You have paid for these set-up costs out of your previous savings. You will not be able to buy any more equipment during the next 12 months. For the year, your total explicit costs are $25 500 and your implicit costs are $45 000. i) Give some examples of your explicit costs. ii) Give some examples of your implicit costs. 111) In your short-run period, how would the law of diminishing returns be likely to apply if the business was doing so well that you started taking on extra staff members? iv) If your total revenue is $80 000, what is your economic profit? Parts i) to iv) are worth 1.5 marks each.

Answer 1

i) Explicit costs are which are monetary payments incurred by the firm. Thus in this example, the explicit costs are which are spent on lease, equipment bought for the business.

ii) Whereas implicit costs are incurred when no actual payment is made, but the business gives up something, wherein there is an opportunity cost incurred. Thus in this case, implicit costs are what I would have earned by working at the full-time job, by earning an interest rate on savings, if I would have not spent it on the business.

iii) Diminishing returns arise when the profits gained at a particular level are less than the amount of money invested. Thus this law will apply if by taking on extra staff members, the cost turns out to be much more than the gain in profit. Thus much more input is used in order to produce additional output. In order to avoid diminishing returns, I would either have to increase space and machinery, so that the additional workers are not hindered and are able to increase output.

iv) Economic profit = Total Revenue - (Explicit + Implicit Costs )

Thus 80,000 - (25,500+ 45,000) = 80,000 - (70,500) = $9,500