Question

1. Mary Jones can work in a factory and earn $16,000 a year or alternatively, be a farmer. Assume that except for monetary reward, she does not care which she does. To farm, Mary must invest her saving of $20,000. The annual cost of seed, fertilizer, etc. is $5000. She would earn 10% annually on her best alternative investment.

1. What is the cost of farming (including implicit cost)?
2. What is the minimum Mary must make in farming to just make it worthwhile?
3. If her revenues are $50,000, what is her economic profit? her accounting profit?
4. Should she stay in farming?
5. What if her revenues are $20,000?

Answer 1

a. Cost of farming = explicit costs + implicit costs

Explicit costs= $5000

Implicit costs= $16,000 + $20,000 + 10% of 20,000 = $ 38,000.

Thus total cost of farming = 5,000 + 38,000 = $43,000

2. The minimum Mary must make it in farming should be equal to her implicit cost. Otherwise her opportunity cost is greater and farming is not a rational alternate. The answer is $38,000.

3. Accounting profit = Revenue - explicit costs = 50,000 - 5,000 = $45,000

Economic profit = Revenue - total costs ( implicit costs+ explicit costs) = 50,000 - 43,000 = $7000

4. Yes, since Mary's economic profit is profit it implies her opportunity cost of leaving farming is greater and she should stay in farming.

5. If revenues are 20,000 then Mary's accounting profit will be postive (15,000) but her economic profit will be negative (- 23,000) thus she should leave farming.