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ECO 550


You have opened your own word-processing service. You bought a personal computer, and paid $5,000 for it. However, due to the cost changes in the computer industry, the current price of an equivalent machine is $2,500. You could sell any used machine for $1,000. If you were not word processing, you could earn $20,000 per year at an alternative job. Assume that the interest rate is 10%. You can also hire an assistant who can do everything that you can do for $20,000 per year (you would still continue to do word processing).

One person using one computer can produce 11,000 typed pages per year, and the price per page for your service is $2.

You are considering three options: (1) expand your business by hiring an assistant; (2) leave your business the way it is; (3) shut down. Based on the costs and revenues above, which should you do? Explain and show any relevant calculations.

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  2. Answer:
    Option 1:
    Revenue = $22,000
    Opportunity cost of your time = 20,000
    Opportunity cost of interest on salvage value of existing computer = 100
    Economic profit = $1,900
    Option 2:
    You still earn $1,900 as above.
    Revenue from additional worker = 22,000
    Wages = 20,000
    Opportunity cost of interest on purchase of new computer = 250
    Depreciation = 1,500
    Economic profit from additional worker = $250
    Total economic profit = $2,150
    Option 3:
    Revenue = 0
    No costs, since opportunity costs no longer apply, and fixed costs are sunk.
    Economic profit = 0
    (Could possibly view the $1,000 you get from selling the used computer as revenue, but makes
    no difference to final solution of problem.)
    Option 2, expand your business, is the best option.

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