Van lives in Chicago and runs a business that sells pianos. In an average year, he receives $709,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of $409,000; he also pays wages and utility bills totaling $281,000. He owns his showroom; if he chooses to rent it out, he will receive $1,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Van does not operate this piano business, he can work as an accountant and receive an annual salary of $29,000 with no additional monetary costs. No other costs are incurred in running this piano business.
Identify each of Van's costs in the following table as either an implicit cost or an explicit cost of selling pianos.
|The wages and utility bills that Van pays|
|The wholesale cost for the pianos that Van pays the manufacturer|
|The rental income Van could receive if he chose to rent out his showroom|
|The salary Van could earn if he worked as an accountant|
Complete the following table by determining Van's accounting and economic profit of his piano business.
Alternatively, the economic profit he would earn as an accountant would be .
If Van's goal is to maximize his economic profit, he stay in the piano business.
True or false: Van is not earning a normal profit because his profit is negative.
IMPLICIT COST : NO 3 AND 4 ARE IMPLICIT COST AS THESE TWO COSTS ARE THOSE OPPORTUNITY COSTS THAT VAN WOULD HAVE EARNED HAD HE BEEN NOT WORKING FOR HIMSELF.
EXPLICIT COST : NO 1 AND 2 ARE EXPLICIT COST AS THESE ARE THE COSTS THAT ARE BORNE DIRECTLY BY VAN HIMSELF.
ACCOUNTING PROFIT = REVENUE - EXPLICIT XOSTS = $709,000 - ( 409,000 + 281,000)
ACCOUNTING PROFIT = $709,000 - $690,000 = $19,000
ECONOMIC PROFIT = ACCOUNTING PROFIT - IMPLICIT COSTS = $19,000 - ($1,000 + $29,000 )
ECONOMIC PROFIT = $19,000 - $30,000 = -$11,000 OR A LOSS OF $11,000.
IF VAN'S GOAL IS TO MAXIMIZE THE ECONOMIC PROFIT , HE SHOULD NOT STAY IN THE PIANO BUSINESS AS HE IS MAKING AN ECONOMIC LOSS OF$11,000.
TRUE VAN IS NOT EARNING A NORMAL PROFIT AS HIS PROFIT IS NEGATIVE (-$11,000).
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