Question

# 1. Definition of economic costs Andrew lives in San Diego and runs a business that sells...

1. Definition of economic costs

Andrew lives in San Diego and runs a business that sells pianos. In an average year, he receives \$704,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of \$404,000; he also pays wages and utility bills totaling \$286,000. He owns his showroom; if he chooses to rent it out, he will receive \$3,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Andrew does not operate this piano business, he can work as an accountant and receive an annual salary of \$20,000 with no additional monetary costs. No other costs are incurred in running this piano business.

Identify each of Andrew's costs in the following table as either an implicit cost or an explicit cost of selling pianos.

Implicit Cost

Explicit Cost

The wages and utility bills that Andrew pays
The wholesale cost for the pianos that Andrew pays the manufacturer
The salary Andrew could earn if he worked as an accountant
The rental income Andrew could receive if he chose to rent out his showroom

Complete the following table by determining Andrew's accounting and economic profit of his piano business.

Profit

(Dollars)

Accounting Profit
Economic Profit

Alternatively, the economic profit he would earn as an accountant would be

If Andrew's goal is to maximize his economic profit, he

• should
• should not

True or false: Andrew is earning a normal profit because his profit is negative.

False

True

Explicit cost is the real cost that has been incurred actually.

Implicit cost is the foregone income that is foregone to pursue a particular action.

The wages and the utility bill...... - explicit cost

The wholesale cost of pianos......- explicit cost

The salary Andrew could......- implicit cost

The rental income Andrew could..... - implicit cost

Accounting profit= revenue - explicit cost

= 704000 - 404000 - 286000

= 14000

Economic profit= accounting profit - implicit cost

= 14000 - 3000 - 20000

= -9000

If Andrew's goal is to maximise economic profit he SHOULD NOT stay in the piano business

False- at normal profit, economic profit is zero.

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