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March 29, 2017

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Please check my answers if they are correct. Thank you.

THE QUESTION:
Mark runs a business that sells guitars. In an average year, he receives $900 000 from sales of guitars. Of the sales revenue, he must pay the manufacturer a wholesale cost of $600 000; he also pays wages and utility bills totalling $200 000. If he does not operate this guitar business, he can work in another business and receive an annual salary of $65 000. He owns his showroom; if he chooses to rent it out, he will receive $40 000 in rent per year. Assume that the value of this showroom does not depreciate over the year. No other costs are incurred in running this guitar business.

i. What are Mark’s explicit costs of selling guitars? Select all that apply.

a) The salary Mark could earn if he worked in another business
b) The wages and utility bills that Mark pays
c) The wholesale cost for the guitars that Mark pays the manufacturer
d) The rental income Mark could receive per year if he chose to rent his showroom out

ii. What is the accounting profit of Mark’s guitar business?

iii. What is the economic profit of Mark’s guitar business?

iv. Taking into accounting Mark’s implicit costs of doing business as well as his explicit costs, if Mark’s only goal is to earn as much economic profit as possible, he ________ (should or should not) continue to stay in the guitar business.

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MY ANSWER:
i. a, b
ii. $900 000
iii. $100 00
iv. He should continue because he is not losing any profits.

  • Economics; The Cost of Production - ,

    First, I am a little concerned about the word, "explicit." I assume that explicit costs are those costs with an actual dollar outlay. (e.g., accounting costs). Further, I will assume that costs that are not explicit (i.e., implicit costs) are the opportunity costs of running the business.
    That said, I disagree with all of your answers:

    i) the explicit costs are b and c, the wholesale costs of the guitars and the wages and utility bills.
    ii) Accounting profits are the 900,000 sales less the explict costs of 600,000 and 200,000 = $100,000
    iii) The economic profit would also subtract out Mark's opportunity costs of running the business; the lost salary of 65,000 and the lost rent of 40,000. Economic profit is -$5,000
    iv) Mark should quit the guitar business and take the salary of 65,000 and the rent of 40,000 and

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