Question

1. Suppose you have an empty garage that costs you roughly $50 per month to maintain in fees related to taxes and insurance. A neighbor asks if it were possible for you to rent the garage to them for $75 per month. If you decide to not rent the garage, but rather just leave it empty what is the total cost of the garage to you? Suppose you rent the garage to the neighbor what is your net profit?

2. You’ve decided to open up a small coffee stand on the corner. As part of this stand you had to invest $80 in a nonrefundable license last year. The cost per cup is expected to be $0.25. During the first week you find that business is booming and you are able to hire a few extra people, but due to the small structure you are working from you can’t expand to serve all of the people until a larger structure can be made and installed. In the above situation, what money would you consider “sunk” or non-refundable? What costs are variable or can be adjusted quickly in the short run? What costs are relatively fixed and are difficult to adjust?

3. In the above example you could hire more people up to a point in which you found they no longer could fit any more workers in the building. Do you think that the workers will be equally productive as you added workers? Why might the conditions make workers less and less productive as you add more workers?

4. Can you think of any types of businesses that would be more efficient (relatively lower cost) as the firm grows (one example might be a bank in which they open up additional branches but have only one central office to handle the transactions)? Can you think of any businesses that would become less efficient as they grow (one example might be specialty carpentry business that relies heavily on the skill set of the founder)?

Answer 1

Question 1

If we decide not to rent the garage and rather just leave it empty then in that case we will incur two costs - One is the explicit cost in terms of fees paid such as taxes and insurance and another is the implicit cost in terms of foregone rent.

So,

Total cost = Explicit cost + Implicit cost = $50 + $75 = $125

Thus,

The total cost of the garage is $125 per month.

If we rent the garage then we can earn $75 per month as revenue and would have to incur $50 per month as maintenance expense.

Net profit = Revenue - Maintenance expense = $75 - $50 = $25

Thus,

The net profit is $25 per month.