Question

Van lives in San Diego and runs a business that sells guitars. In an average year, he receives $851,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $476,000; he also pays wages and utility bills totaling $281,000. He owns his showroom; if he chooses to rent it out, he will receive $71,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Van does not operate this guitar business, he can work as an accountant and receive an annual salary of $34,000 with no additional monetary costs. No other costs are incurred in running this guitar business.Identify each of Van's costs in the following table as either an implicit cost or an explicit cost of selling guitars.1) The wages and utility bills that Van pays a) implicit cost or b) explicit cost2) The wholesale cost for the guitars that Van pays the manufacturer a) implicit cost or b) explict cost3)The rental income Van could receive if he chose to rent out his showroom a) implicit cost or b) explicit cost4) The salary Van could earn if he worked as an accountant a) implicit cost or b) explicit costComplete the following table by determining Van's accounting and economic profit of his guitar business.Profit(Dollars)Accounting Profit Economic Profit 5) If Van's goal is to maximize his economic profit, he (should or should not?) stay in the guitar business because the economic profit he would earn as an accountant would be ($_________).

Answer 1

Answer:

a) 1) The wages and utility bills that Van pays :explicit cost

2) The wholesale cost for the guitars that Van pays the manufacturer: explict cost

3)The rental income Van could receive if he chose to rent out his showroom: implicit cost

4) The salary Van could earn if he worked as an accountant: implicit cost

b)

Accounting profit = $105,000

Guitar shop profit  = $94,000

c) He should not stay in the guitar business beacuse the economic profit he would earn as an accountant would be $105,000.

Explanation:

The cost that are explicit are the cost it actually pays for int he actual situation. The implicit cost are the earnings he is not having because of the options he has taken (in this case, have a guitar shop).

1) The wages and utility bills that Van pays :explicit cost

2) The wholesale cost for the guitars that Van pays the manufacturer: explict cost

3)The rental income Van could receive if he chose to rent out his showroom: implicit cost

4) The salary Van could earn if he worked as an accountant: implicit cost

b)

Accounting profit = Accounting earnings + rental income

Accounting profit = 34,000+71,000 = $105,000

Guitar shop profit = Sales - (wholesale cost+wages)

Guitar shop profit = 851,000 - (476,000+281,000) = $94,000

c) If he wants to maximize his profit he should work as an accountant and rent the showroom, because he would earn $105,000 instead of $94,000 he is making with the guitar shop.

Answer 2

Answer:

1) The wages and utility bills that Van pays is explicit cost.

2) The wholesale cost for the guitars that Van pays the

    manufacturer  is explicit cost.

3) The rental income Van could receive if he chose to rent out

    his showroom is implicit cost.

4) The salary Van could earn if he worked as an accountant is

    implicit cost.

Accounting Profit                       Dollars($)

Sales Revenue                                   851,000

Less Cost of Goods Sold                  (476,000)

Gross Profit                                         375,000

Less explicit cost:

Wages & Utility Bills                             (281,000)

Accounting Profit                                  94,000

Economic profit                                      Dollars($)

 Accounting Profit                                      94,000

Less implicit costs:

Rental Income Van could receive              (71,000)

Salary Van could earn as Accountant       (34,000)

Economic Profit                                           (11,000)

5) If Van's goal is to maximize his economic profit, he should not stay in the guitar business because the economics profit he would earn as an  accountant would be ($105,000).

Explanation:

Formulas

   Accounting Profit = Total Revenues - Explicit Costs

   Economic Profit = Accounting Profit - Implicit Costs

   Economic Profit = Total Revenues - (Explicit Costs + Implicit

                                  Costs)

Economic profit is differ from accounting profit. Accounting profit is a company revenue minus its explicit costs. Explicit costs are business expenses. These are payments made for day-to-day running of business. Examples are utilities, wages, rent, etc.

Economic profit considers implicit costs such as opportunity costs gave up in order to run the business.