Question

The Question, I would like you to include some IMPLICIT COSTS and BENEFITS in your calculations to come up with a revised accounting profit and recommendation on whether or not to return to the factory job.

The senario, A carpenter quits his job at a furniture factory to open his own cabinetmaking business. In his first two years of operation, his sales average $100 000 and his operating costs for wood, workshop and tool rental, utilities, and miscellaneous expenses average $70 000. Now his old job at the furniture factory is again available.

Should he take it or remain in business for himself? How would you make this decision?

His average sales revenue are 100000 which is greater than the average expense (operational cost=70000). That means he is getting some benefit (accounting and economic profit=30000) from his business.

Expecting that his decision was rational, we can assume that his previous job must have a salary of less than 30000. If that is the case, he should not opt his business if his job offers him the same salary. Instead, if we assume that he did not consider his implicit cost, his salary must have been higher than 30000. In that case, if his job offers him the same salary, then the business has an economic loss and he should go back to the factory job.

Answer 1

ANSWER:

First of all let me tell you with the current scenario the accounting profit will be the same that is $30,000.

it is the economic profit that will change if we include the implicit costs ( like salary foregone when not working in the factory ans the income he could have earned from renting the space he is using for making furniture).

so lets assume the salary foregone to be $20,000 ( logically it should be less then the profit he is earning from doing his own business).

the rent he could have earned from giving his space to some other firm is $15,000 per year.

so now his total implicit cost are = salary foregone + rent that he could have earned = $20,000 + $15,000 = $35,000.

now his economic profit will be = accounting profit - implicit cost = $30,000 - $35,000 = -$5,000

so he is making an economic loss and would be better off working in factory.