Question

Kevin lives in New York City and runs a business that sells pianos. In an average year, he receives $735,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of $435,000; he also pays wages and utility bills totaling $255,000. He owns his showroom; if he chooses to rent it out, he will receive $10,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Kevin does not operate this piano business, he can work as an accountant, receive an annual salary of $24,000 with no additional monetary costs, and rent out his showroom at the $10,000 per year rate. No other costs are incurred in running this piano business.
Identify each of Van's costs in the following table as either an implicit cost or an explicit cost of selling pianos.
Implicit Cost Explicit Cost

The wages and utility bills that Van pays
The wholesale cost for the pianos that Van pays
the manufacturer
The rental income Van could receive if he chose to
rent out his showroom
The salary Van could earn if he worked as an accountant
Complete the following table by determining Van's accounting and economic profit of his piano business.
Profit
(Dollars)
Accounting Profit
Economic Profit
Alternatively, the economic profit he would earn as an accountant would be____.
If Van's goal is to maximize his economic profit, he stay in the piano business.
Van is not earning a normal profit because his profit is negative.
A. True
B. False

Answer 1

Answer:

Implicit Cost and Explicit Cost

Identification of Van's cost as either an implicit cost or an explicit cost of selling pianos:

Implicit costs:

The rental income Van could receive if he chose to  rent out his showroom

The salary Van could earn if he worked as an accountant

Explicit costs:

The wages and utility bills that Van pays

The wholesale cost for the pianos that Van pays  the manufacturer

2. Determining Van's accounting and economic profit of his piano business.

Profit

(Dollars)

                         Accounting Profit    Economic Profit

Sales revenue      $735,000             $735,000

Cost of pianos       (435,000)             (435,000)

Wages and Utility  (255,000)             (255,000)

Opportunity costs:

Rent                                                        (10,000)

Salary as an accountant                       (24,000)

Profit                      $45,000                $11,000

3. Alternatively, the economic profit he would earn as an accountant would be_$34,000___.

4. If Van's goal is to maximize his economic profit, he stay in the piano business.

False

5. Van is not earning a normal profit because his profit is negative.

B. False

Explanation:

Van's economic profit or loss is the difference between the revenue received from the sale of the pianos and the costs of all inputs used, as well as opportunity costs of forgone rent revenue and salary income as an accountant.  To compute economic profit, opportunity costs and explicit costs are deducted from revenues earned.  But to compute accounting profit, only the explicit costs are deducted from revenues earned.