Question

Suppose a firm has an annual budget of $200,000 in wages and salaries, $75,000 in materials, $30,000 in new equipment, $20,000 in rented property, and $35,000 in interest costs on capital. The owner/manager does not choose to pay himself, but he could receive income of $90,000 by working elsewhere. The firm earns revenues of $360,000 per year. To receive a normal profit, the firm described above would have to

Multiple Choice

• Do nothing since it already earns a normal profit.

• Earn $10,000 more in revenue.

• Earn $90,000 more in revenue.

• Experience $10,000 less in cost.

Answer 1

Answer : The answer is option C.

Firm earn normal profit when total revenue is equal to total cost. Total cost include both explicit cost and implicit cost. So,

Total cost = Explicit cost + Implicit cost

Explicit cost = 200,000 + 75,000 + 30,000 + 20,000 + 35,000 = $360,000.

Implicit cost = $90,000

Total cost = 360,000 + 90,000 = $450,000.

Here the total revenue is less than the total cost by (450,000 - 360,000) = $90,000. So, to earn normal profit the firm have to earn $90,000 more as revenue.