Managerial Economics

During a year of operation, a firm collects $175,000 in revenue and spends $80,000 on raw materials, labor expense, utilities, and rent. The owners of the firm have provided $500,000 of their own money to the firm instead of investing the money and earning a 14 percent annual rate of return.

a. The explicit costs of the firm are $80,000. The implicit costs are $70,000. Total economic cost is $150,000. b. The firm earns economic profit of $25,000.
c. The firm’s accounting profit is $95,000.
d. If the owners could earn 20 percent annually on the money they have invested in the firm, the economic profit of the firm would be $ – 5,000 (when revenue is $175,000).

a. Explicit cost (market – supplied resources) = $80,000
Implicit cost (owner – supplied resources) = 50,000 * 14% = $70,000 Total economic cost = explicit cost + implicit cost = $150,000

b. Economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost = 175,000 – 150, 000 = $25,000

c. Accounting profit = total revenue – explicit cost
= 175,000 – 80,000 = $95,000

d. Economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost = 175,000 – 80,000 – 500,000 * 20% =$ – 5,000

Applied problems

At the beginning of the year, an audio engineer quit his job and gave up a salary of $175,000 per year in order to start his own business, Sound Devices, Inc. The new company builds, installs, and maintains custom audio equipment for business that requires high-quality audio systems.

To get started, the owner of Sound Devices spent $100,000 of his personnel savings to pay for some of the capital equipment used in the business. In 2007, the owner of Sound Devices could have earned a 15 percent return by investing in stocks of other new businesses with risk levels similar to the risk level at Sound Devices. a. What are the total explicit, total explicit, and total economic costs in 2007? b. What is accounting profit in 2007?

c. What is economic profit in 2007?
d. Given your answer in part c, evaluate the owner’s decision to leave his job to start Sound Devices. a. Explicit cost = total operating cost and expenses = $555,000 Implicit cost = 100,000 * 15% = $15,000

Total economic cost = explicit cost + implicit cost
= 555,000 + 15,000 = $570,000

b. Accounting profit = total revenue – explicit cost
= 970,000 – 555,000 = $415,000

c. Economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost =970,000 – 555,000 – 15,000 = $400,000

d. According to the accounting profit and economic profit can understand that it is correct for this audio engineer to give up a salary of $175,000 per year in order to start his own business, the profit he earns from his company is large than his salary.

When Burton Cummings graduated with honors from the Canadian Trucking Academy, his father gave him a $350,000 tractor-trailer rig. Recently, Burton was boasting to some fellow truckers that his revenues were typically $25,000 per month, while his operating costs (fuels, maintenance, and depreciation) amounted to only $18,000 per month. Tractor-trailer rigs identical to Burton’s rig rent for $15,000 per month. If Burton was driving trucks for one of the competing trucking firms, he would earn $5,000 per month.

a. How much are Burton Cummings’s explicit costs per month? How much are his implicit costs per month? b. What is the dollar amount of the opportunity cost of the resources used by Burton Cummings each month? c. Burton is proud of the fact that he is generating a net cash flows of $7,000 (=$25,000 – $18,000) per month, since he would be earning only $5,000 per month if he were working for a trucking firm. What advice would you give Burton Cummings?

a. Explicit cost = $18,000
Implicit cost = $350,000

b. Opportunity cost = market – supplied resources (explicit cost) + owner – supplied resources (implicit cost) = 18,000 + 350,000 = $368,000

c. accounting cost =$7,000
economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost = 25,000 – 18,000 – 350,000 = $ – 343,000

It can be known that his economic profit of per month is negative. Since the owners of firms must cover the costs of all resources and by the firm, maximizing economic profit, rather that accounting profit, is the objective of the firm’s owners. Therefore, actually it cannot be considered as the profit situation.

Suggestions:
Assuming that he rents a same truck which rent price is $15,000 other than use the truck which given by his father, therefore, his implicit cost is zero, explicit cost = 18,000 + 15,000 = $33,000. Therefore, economic profit = 25,000 – 18,000 – 15,000 = $ – 8,000 accounting profit = 25,000 – 33,000 = $ – 8,000, economic profit = accounting profit

Then he rent the truck which given by his father can get a profit of $15,000 each month. Therefore, the final economic profit of per month = -8,000 + 15,000 = $ 7,000 Accounting profit = – 8,000 + 15,000 = $ 7,000.

Therefore, his profit of per month is $7,000, which is larger than the profit in other trucking company.

Explain why it would cost Andre Agassi or Venus Williams more to leave the professional tennis tour and open a tennis shop that it would for the coach of a university tennis team to do so.

Firstly, the profit is stable to coach a university tennis team, and there is no any risk, it needs not to cost own investment to rent ground and equipment, therefore, it can save the implicit cost and explicit cost.

Moreover, the profit is instable to run a tennis shop, and it also is risky, it needs the own investment to rent house, goods and equipment. Thus can increase the implicit cost and explicit cost, his economic profit, accounting profit will be changed with the changes of total revenue, implicit cost and explicit cost.

In brief, run a tennis shop will pay much more than coaching a university tennis team.