Question

Brian lives in Denver and runs a business that sells pianos. In an average year, he receives $704,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of $404,000. He also pays wages and utility bills totaling $286,000. He owns his showroom; if he chooses to rent it out, he will receive $3,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Brian does not operate this piano business, he can work as an accountant and receive an annual salary of $20,000 with no additional monetary costs. No other costs are incurred in running this piano business.

1. Identify each of Brian'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 Brian pays the manufacturer
The salary Brian could earn if he worked as an accountant
The wages and utility bills that Brian pays
The rental income Brian could receive if he chose to rent out his showroom
2. Complete the following table by determining Brian's accounting and economic profit of his piano business.

Profit $
Accounting Profit
Economic Profit
If Brian's goal is to maximize his economic profit, should he stay in the piano business or rather work as an accountant?

Answer 1

Answer:

Explicit cost :

The wholesale cost for the pianos that Brian pays the manufacturer

The wages and utility bills that Brian pays

Implicit cost:

The salary Brian could earn if he worked as an accountant

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

Accounting profit = $14,000

Economic profit = $-9,000

He should stop selling painos. He should work as an accountant

Explanation:

Explicit cost is total actual cost incurred in running a business.

Implicit cost is the opportunity cost of running the piano business. It is the cost of the next best option forgone when one alternative is chosen over other alternatives.

Accounting profit = Total revenue - Total explicit cost

Total revenue = $704,000

Total explicit cost = $404,000 + $286,000 = $690,000

Accounting profit = $704,000 - $690,000 = $14,000

Economic profit is accounting profit less implicit cost or opportunity cost.

Economic profit = Accounting profit - Opportunity cost

Opportunity cost = $20,000 + $3,000 = $23,000

Economic profit = $14,000 - $23,000 = $-9,000

He should work as an accountant instead since his economic profit is negative. He would earn more working as an accountant than selling pianos

I hope my answer helps you.