Question

One year ago, Ms. Case and Mr. Bond opened a jewelry store called T & J. They invested $1,000,000 of their savings into the partnership to buy equipment and initial inventory. They rented a building for $90,000 a year, and hired two employees for an annual wage of $40,000 each. Case and Bond believed that the best alternative investment of their money would be government bonds, which could yield an annual return of 8 percent. To run the store, Case quit her previous job, at which she earned $100,000, but her former boss told her that she was welcome to return anytime. Bond kept his job with the government, but gave up 6 hours of leisure each week (for 50 weeks), the time he used to spend playing golf. Bond used to say: "I'd only give up my golf time if someone paid me $100 an hour." During the first year of operation, T & J paid $20,000 for utilities and the firm's total revenue was $350,000. The market value of T & J's equipment was $200,000 at the beginning of the year and $170,000 at the end of the year.

What is the economic depreciation of their capital?

What are T & J's opportunity costs?

What is the firm's economic profit in the first year of operation?

Answer 1

1) Solution: $30,000

Explanation: Economic depreciation = Market value of equipment at the beginning of the year - market value of equipment at the end of the year = 200,000 - 170,000 = 30,000

　

2) Solution: $430,000

Explanation:

Rent	90,000
Wages	80,000
Utilities	20,000
Economic depreciation	30,000
Interest forgone ($1,000,000 × 0.08)	80,000
Opportunity cost of the owners' resources
Wage at the previous job	100,000
Bond ($100 × 300)	30,000
	430,000

3) Solution: -$80,000

Explanation: Economic profit = Total revenue - Total opportunity cost = $350,000 - $430,000 = -$80,000