what are explicit costs and implicit costs in this question?
mohammed aa Asked: what are explicit costs and implicit costs in this question?
You are given the following information about a small woodworking business. The owner of the business pays one employee $20,000 a year, his rent is $5,000 a year and his costs for wood and other inputs are $50,000 a year. He gave up a job paying $40,000 a year to start his own business. He invested $80,000 of his own money that had been earning $5,000 a year in interest. He is spending $10,000 to send catalogs to customers. He earns $100,000 in revenue during the year. total revenue is 100,000.
Answers:
Explicit costs: Costs involving the running of a business – purchases, rent, etc. Here the explicit costs are the wage, rent, input and catalogue costs ($20,000 + $5,000 + $50,000 + $10,000 = $85,000).
Implicit costs: The opportunity cost of the best forgone opportunity. Here, the owner has given up a job paying $45,000, and an annual return of $5,000 in interest ($50,000 total implicit costs).
Accounting profit = Total costs – explicit costs = $100,000 – $85,000 = $15,000.
Economic profit takes forgone opportunities into account, to provide a fuller account of how well resources are being utilised. Economic Profit = Total costs – (explicit + implicit costs) = $100,000 – ($50,000 + $85,000) = -$35,000. The owner is making an economic loss despite his accounting profit, indicating that his resources would be better utilised in his previous occupation. If this is expected to continue, we would expect him to move into a different market in the long term.
