Question

Larry lives in Chicago and runs a business that sells guitars. In an average year, he receives $793,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $430,000; he also pays wages and utility bills totaling $301,000. He owns his showroom; if he chooses to rent it out, he will receive $15,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Larry does not operate this guitar business, he can work as a financial advisor, receive an annual salary of $50,000 with no additional monetary costs, and rent out his showroom at the $15,000 per year rate. No other costs are incurred in running this guitar business.
Required:
(a) Identify each of Charles's costs in the following table as either an implicit cost or an explicit cost of selling guitars.
1. The wages and utility bills that Brian pays.
2. The rental income Brian could receive if he chose to rent out his showroom.
3. The salary Brian could earn if he worked as a financial advisor.
4. The wholesale cost for the pianos that Brian pays the manufacturer.
(b) Complete the following table by determining Brian's accounting and economic profit of his piano business.
Profit
(Dollars)
Accounting Profit
Economic Profit

Answer 1

Answer:

a)

1. Explicit cost

2. Implicit Cost

3. Implicit Cost

4. Explicit cost

b)

Accounting Profit is $62000.

Economic Profit is -$3000. (a loss of $3000)

Explanation:

a)

Explicit costs are those costs incurred by a business that require an outlay of money as a result of operating a business.

Implicit costs, on the other hand, are the costs that do not require an outlay of money as a result of operating a business. They are instead the opportunity costs of operating a business or the benefits that are foregone.

1. The wages and utility bills are a result of operating a business and requires and outlay of money as their payment. They are explicit costs.

2. The rental income could have been earned if Larry rented the showroom he is using to operate his business from. The rent foregone is an opportunity cost and is an implicit cost.

3. The salary Larry could have earned is also something that Brian has to forego to operate his business and is an implicit cost.

4. The cost of purchases paid to manufacturer requires outlay of money and is an explicit cost.

b)

Accounting profit = Total Revenue - Total explicit cost

Economic profit =  Total revenue - (Total Explicit Cost + Total Implicit Cost)

Accounting Profit = 793000 - 430000 - 301000 = $62000 profit

Economic profit = 793000 - (430000 + 301000 + 15000 + 50000) = -$3000 loss