Question

1. Definition of economic costs Lorenzo lives in Houston and runs a business that sells pianos. In an average year, he receives $722,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of $422,000; he also pays wages and utility bills totaling $268,000. He owns his showroom; if he chooses to rent it out, he will receive $1,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Lorenzo does not operate this piano business, he can work as an accountant, receive an annual salary of $42,000 with no additional monetary costs, and rent out his showroom at the $1,000 per year rate. No other costs are incurred in running this piano business. Identify each of Lorenzo's costs in the following table as either an implicit cost or an explicit cost of selling pianos. Implicit Cost Explicit Cost The wholesale cost for the pianos that Lorenzo pays the manufacturer The rental income Lorenzo could receive if he chose to rent out his showroom The wages and utility bills that Lorenzo pays The salary Lorenzo could earn if he worked as an accountant Complete the following table by determining Lorenzo's accounting and economic profit of his piano business. Profit (Dollars) Accounting Profit Economic Profit

Answer 1

Explicit cost is the actual payment made for running a business whereas implicit cost is the opportunity cost and though it is incurred, there is no payment.

1. Explicit cost

2. Implicit cost

3. Explicit cost

4. Implicit cost

Accounting profit = Total revenue - total cost

= 722000-(42200+268000)

= 722000- 310200

= 411800

Economic profit also includes the opportunity cost.

= Total revenue - total cost - opportunity cost

= 722000-310200-1000-42000

= 368800