# economics

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I tried answering b, but stuck with a. Can someone please take a look at this and help me out? Also check, if answer to b is correct?

1)Bob and Jane decide to open their own business selling ergonomically correct office furniture that Jane has designed. They have so much faith in the potential of Jane’s designs that they quit corporate jobs in marketing and MIS administration (which jointly had earned them \$250,000 per year), and sink \$500,000 (.5 million) of their own funds into this venture at the start of their first year to place advertising in trade journals and on the internet. (Assume this \$500,000 had previously been invested in a diversified portfolio that had been averaging a 10% annual before tax rate of return.) At the end of the year they calculated that they had the following costs and revenues.

Total Revenues: \$5.0 million

Costs:
Payments to furniture subcontractors \$3.5 million
Shipping Costs .1 million
Lease Payments on Office Space and Computer
Equipment &Software \$ .1 million
Overhead Expenses: Insurance, utilities etc. \$ .1 million
(Purchased at start of year) \$ .5 million
Entertaining clients etc.)

Total Listed Costs = \$4.5 million

a) Is Bob & Jane's economic profit different from their accounting profit? If so, how much economic profit did they earn during this first year of operation?

b) What were Bob & Jane's fixed costs during their first year of operation ?
Is this correct?

Payments to furniture subcontractors \$3.5 million

Lease Payments on Office Space and Computer Equipment &Software \$ .1 million

Overhead Expenses: Insurance, utilities etc. \$ .1 million

Advertising on Internet & Magazines(Purchased at start of year) \$ .5 million

• economics -

Total revenues are 5.0, total costs are 4.5, so accounting profit is \$500,000 However, Bob and Jane, while likely working just as hard before, gave up \$250,000 in wages. Add to this the \$50,000 in lost interest income. So, economic profit is 500,000 - 300,000 = \$200,000

• economics -

thanks! Is b correct?

• economics -

I would characterize payments to the subcontractors as variable costs, NOT fixed costs.
Lease Payments and Overhead are definately fixed costs. I would count advertising as a fixed cost (as it was purchased at the start of the year). However, one could argue that advertising costs are variable costs.

• economics -

o.6

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