Question

Fred earns $50,000 business profit per year by selling donuts. He pays $12,000 per year in rent to his Uncle George for the building in which his business is located. If his Uncle George gives him the building, then Fred's A. business profit will increase by $12,000 per year. B. economic profit will increase by $12,000 per year. C. implicit cost will decrease by $12,000 per year. D. All of the above are correct.

Answer 1

Part A is correct. Business profit will increase by $12,000 per year.

Elimination Method: Part C cannot be correct as paying rent was not an implicit cost. This implies Part D is also ruled out. We are left with Part A and Part B. Note that in Part B profits are economic. The question states business profits. After Uncle George gives the building to Fred, the effect would not have any effect on the economic profits. Hence Part B is also ruled out. We are left with Part A which is the solution to the question.