Question

Edison lives in Chicago and runs a business that sells guitars. In an average year, he receives $726,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $426,000; he also pays wages and utility bills totaling $264,000. He owns his showroom; if he chooses to rent it out, he will receive $13,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Edison does not operate this guitar business, he can work as a paralegal, receive an annual salary of $22,000 with no additional monetary costs, and rent out his showroom at the $13,000 per year rate. No other costs are incurred in running this guitar business.
A) Identify each of Rajiv's costs in the following table as either an implicit cost or an explicit cost of selling guitars.
Implicit Cost Explicit Cost
The rental income Darnell could receive if he
chose to rent out his showroom.
The wages and utility bills that Darnell pays.
The salary Darnell could earn if he worked as a
financial advisor.
The wholesale cost for the pianos that Darnell pays
the manufacturer.
B) Complete the following table by determining Rajiv's accounting and economic profit of his guitar business.
Profit (Dollars)
Accounting Profit
Economic Profit
C) If Darnell's goal is to maximize his economic profit, he should stay in the piano business because the economic profit he would earn as a financial advisor would be _____.

Answer 1

Answer:

The rental income Darnell could receive if he  chose to rent out his showroom. - implicit cost  

The wages and utility bills that Darnell pays. - explicit cost  

The salary Darnell could earn if he worked as a  financial advisor. implicit cost  

The wholesale cost for the pianos that Darnell pays  the manufacturer. explicit cost

If Darnell's goal is to maximize his economic profit, he should not stay in the piano business because the economic profit he would earn as a financial advisor would be $35,000

Explanation:

 Explicit cost includes the amount expended in running the business. They include rent , salary and cost of raw materials

Implicit cost is the cost of the next best option forgone when one alternative is chosen over other alternatives

Accounting profit= total revenue - explicit cost

$726,000 - ( $426,000 +  $264,000) = $36,000

Economic profit = accounting profit - implicit cost

$36,000 - (13,000 + 22,000) = $-1,000

Economic profit from not running the piano business = $13,000 + $22,000 = $35,000

The economic profit from not running the piano business is higher than the economic profit of running it. Thus, he would choose not to run the piano business