Question

Felix lives in Detroit and runs a business that sells guitars. In an average year, he receives $722,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $422,000; he also pays wages and utility bills totaling $268,000. He owns his showroom; if he chooses to rent it out, he will receive $2,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Felix does not operate this guitar business, he can work as a paralegal, receive an annual salary of $21,000 with no additional monetary costs, and rent out his showroom at the $2,000 per year rate. No other costs are incurred in running this guitar business.
Identify each of Felix’s costs in the following table as either an implicit cost or an explicit cost of selling guitars.
1. Implicit Cost
2. Explicit Cost
The wholesale cost for the guitars that Felix pays the manufacturer
The rental income Felix could receive if he chose to rent out his showroom
The salary Felix could earn if he worked as a paralegal
The wages and utility bills that Felix pays
Complete the following table by determining Felix’s accounting and economic profit of his guitar business.
Profit
(Dollars)
Accounting Profit
Economic Profit

Answer 1

Answer:

Wholesale cost for the guitar - Explicit Cost

Rental income foregone  - Implicit Cost

Salary foregone - Implicit Cost

Wages and utility bills paid - Explicit costs

Accounting Profit = $32000

Economic Profit = $9000

Explanation:

Explicit costs refer to the out of pocket costs which are actually incurred. Implicit costs are the costs associated with the options foregone or the prospective costs. Such costs are referred to as Opportunity costs in economics.

Economic profit differs from Accounting profit in the sense that such profit takes into account opportunity costs.

Opportunity costs refer to the the cost of foregone option when another option is chosen instead,

In the given case, Salary that could be earned , rental income that could be earned represent implicit or opportunity costs.

Whereas, wholesale costs and utility bill payments have been actually incurred and thus refer to explicit costs.

Accounting profit = Revenues - Explicit costs

Accounting profit = $722,000 - $422,000 - $268,000 = $32,000

Economic profit = Accounting profit - Implicit costs = $32,000 - $2000 - $21,000

Thus, Economic Profit = $ 9000