Question

Suppose Alex owns a business making quilts that generates $7,000 a month in revenue. Each month, Alex spends $1,500 on fabric and other sewing materials, and he pays his two employees a combined total of $4,000 per month (they each earn $2,000). Alex makes his quilts in a workshop he has set up in his basement. If Alex did not own the quilt business, he would work as a yoga instructor earning $2,300 per month, and he would use the basement as a TV room, an option he would value at $40 per month.

a. What is Alex's accounting profit?

b. What is Alex's economic profit?​

c. If the market for quilts is perfectly competitive, and other quilt producers face the same costs as Alex, then what would you expect to happen to both the number of firms making quilts and the equilibrium price of quilts in the long run. Briefly explain.

You would expect firms to enter the industry. This would lead the equilibrium quantity of quilts to rise and the equilibrium price to fall.

You would expect firms to exit the industry. This would lead the equilibrium quantity of quilts to rise and the equilibrium price to fall.

You would expect firms to exit the industry. This would lead the equilibrium quantity of quilts to fall and the equilibrium price to rise.

You would expect firms to enter the industry. This would lead the equilibrium quantity of quilts to fall and the equilibrium price to rise.

Answer 1

Answer:

Explanation:

Total revenue = $7,000

Explicit cost = $1500 + $4000 = $5,500

[Explicit costs are normal business costs that appear in the general ledger and directly affect a company's profitability]

Implicit cost = $2300 + $40 = $2,340 (Indirect expenses or opportunity cost of not choosing other available options)

[Implicit cost represents an opportunity cost]

a) Accounting profit = Total revenue - Explicit cost = $7,000 - $5,500 = $1,500

b) Economic cost =  Total revenue - Explicit cost - Implicit cost = $7,000 - $5,500 - $2,340 = - $840

c)

Market for quilts is perfectly competitive, and other quilt producers face the same costs as Alex.

You would expect firms to exit the industry. This would lead the equilibrium quantity of quilts to fall and the equilibrium price to rise.

Negative economic profits will cause firms to exit the industry and positive economic profits attract firms in the industry. According to calculations,  economic profit is negative and firms will leave the industry. This will decrease the market supply. Equilibrium quantity will fall and price will rise because there is a negative economic profit.