Worksheet 1

Implicit/Explicit Costs and Accounting/Economic Profit

1. Mr Ravi is a lawyer and he works for a law firm. His annual salary is Rs 60,000.
He is thinking of setting up his own law firm. He estimates that renting an office would
cost Rs 10,000 per year, hiring a legal secretary would cost Rs 20,000 per year, renting
the required office equipment would cost Rs 15000 per year. Purchasing the required
supplies, paying for electricity etc would cost another Rs 5000 per year. He also
estimates that total revenue for the year would be Rs 1,00,000.
Find out:
a. Explicit cost of running his own law office for the year
b. Accounting cost.
c. Implicit cost
d. Economic costs
e. On the basis of your economic analysis, pls advise Mr. Ravi whether he should go
ahead and start his own practice or not?

2. The cost of attending private college for one year is $6000 for tuition, $2000 for the
room, $1500 for the meal, $500 for the books. The student could have also earned
$15000 by getting a job instead of going to college and 10% interest on expenses he or
she incurs at the beginning of the year. Calculate explicit, implicit and total economic
cost of attending college.

3. Woman managing a photocopying establishment for $25000 per year decides to open
her own duplicating center. Her revenue during the first year of operation is $120,000
and her expenses are:
Salaries to hired help $45000
Supplies 15000
Rent 10000
Utilities 1000
Interest on bank loan 10,000

Calculate (a) Explicit cost (b) Implicit Cost (c) Accounting profit
(d) Economic profit

4. Joe runs a small boat factory. He can make ten boats per year and sell them for $25,000
each. It costs Joe $150,000 for the raw materials (fiberglass, wood, paint, and so on) to
build the ten boats. Joe has invested $400,000 in the factory and equipment needed to
produce the boats which are now assets that he owns: $200,000 from his own savings
and $200,000 borrowed at 10 percent interest (assume that Joe could have loaned his
money out at 10 percent, too). Joe can work at a competing boat factory for $70,000 per
year. Hint: The funds invested in the factory and equipment ($400,000) are not treated
as a cost here because they represent assets of the firm, there is however a cost
associated with obtaining these funds.
 a. What is the total revenue Joe can earn in a year?
b. What are the explicit costs Joe incurs while producing ten boats?
c. What are the total costs of producing ten boats (explicit and implicit)?
d. How much is Joe’s accounting profit?
e. How much is Joe’s economic profit?
f. Is it truly profitable for Joe to operate his boat factory? Briefly explain.

5. Assume that after graduation you decide to open your own economics consulting firm. In
doing so you give up the opportunity to work for Megabank financial services, where you
would have been earning $45,000 per year. In order to start your firm, you withdraw
$20,000 from a low-risk account that was earning 8% interest annually. After a year of
operations, you have the following information regarding costs and revenues. Revenue =
$170,000 (1700 hours of consulting at a price of $100 per hour) Labor expenses = $20,000
Rent = $18,000, other expenses = $15,000

A. How much are your accounting costs?

B. How much are your economic costs?
C. How much are your accounting profits?
D. How much are your economic profits?

6. Lara’s interior designs sells 500 hours of consulting services at $50.00 per hour in 1999.
The explicit costs associated with providing this amount of consulting is $10,000. Laura’s
economic profits for 1999:

A. Equal $25,000
B. Equal $20,000
C. Equal $15,000
D. Cannot be determined without more information

7. After working as a head chef for years, Jared gave up his $60,000 salary to open his own
restaurant last year. He withdrew $50,000 of his own savings that had been earning 4% interest
and borrowed another $100,000 from the bank at a rate of 5%. As the restaurant space he was
leasing had no separate office, Jared converted his basement apartment into office space. He had
previously rented the apartment to a student for $300/month. The following table summarizes
his operations for the past year.

Total sales revenue   $590,000

       
  Employee wages $120,000  
  Materials $350,000  
  Interest on loan $5,000  
  Utilities $10,000  
  Rent $25,000  
 Total explicit costs   $510,000

a. What is Jared's accounting profit?

b. Suppose Jared could have used his talents to run a similar kind of business instead. If he
values his entrepreneurial skill at $10,000 annually, find Jared's total implicit costs.
c. What was Jared's economic profit last year (based upon the calculation of implicit cost in
part b above)?