Raphael lives in Denver and runs a business that sells guita

Raphael lives in Denver and runs a business that sells guitars. In an average year, he receives $723,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $423,000; he also pays wages and utility bills totaling $267,000. 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 Raphael does not operate this guitar business, he can work as a financial advisor and receive an annual salary of $20,000 with no additional monetary costs. No other costs are incurred in running this guitar business. Identify each of Raphael\'s costs in the following table as either an implicit cost or an explicit cost of selling guitars. Complete the following table by determining Raphael\'s accounting and economic profit of his guitar business. If Raphael\'s goal is to maximize his economic profit, he stay in the guitar business because the economic profit he would earn as a financial would be . Raphael is earning a normal profit because is positive.

Solution

Implicit Cost

A cost that is represented by lost opportunity in the use of a company\'s own resources, excluding cash.

Implicit costs are the economic profits sacrificed in not undertaking the resource\'s alternate use.

Explicit Cost

A business expense that is easily identified and accounted for. Explicit costs represent clear, obvious cash outflows from a business that reduce its bottom-line profitability.
Explicit costs represent actual payments to other parties in return of a resource.

Answers to the questions

1. Implicit Cost

2. Explicit Cost

3. Implicit Cost

4. Explicit Cost

Accounting Profit:

Annual sales                           $ 723,000

Manufacturing Expense $ (423,000)

Wages and utility bills             $ (267,000)

Accounting Profit                    $   33,000

Economic Profit:

Economic profit equals a firm\'s total revenues less its total economic costs. Economic costs are the sum of explicit costs and implicit costs.

Annual sales                $   723,000

Implicit Cost              $    (22,000) [rent 2,000+ salary 20,000]

Explicit Cost               $ (690,000) [423,000+267,000]

Economic Profit          $     11,000