Answer to Question #135496 in Microeconomics for John

Question

3. Mary Graham worked as a real estate agent for Piedmont Properties for 15 years.

Her annual income is approximately $100,000 per year. Mary is considering establishing her own real estate agency. She expects to generate revenues during the first year of $2 million. Salaries paid to her employees are expected to total $1.5 million. Operating expenses (i.e., rent, supplies, utility services) are expected to total $250,000. To begin the business, Mary must borrow $500,000 from her bank at an interest rate of 15 percent. Equipment will cost Mary $50,000. At the end of one year, the value of this equipment will be $30,000, even though the depreciation expense for tax purposes is only $5,000 during the first year.

a. Determine the (pre-tax) accounting profit for this venture.

b. Determine the (pre-tax) economic profit for this venture.

c. Which of the costs for this firm are explicit and which are implicit?

Answer 1

Following information is available about Mary Graham’s revenue and cost.

a. Accounting profits are the difference between the total revenue and explicit costs, where explicit are the direct payments made in the course of a business.

b. Economic profits are the difference between the total revenue and the total of explicit and implicit costs. Implicit costs are costs of opportunity lost by using company’s own resources instead of putting these to some different use.

c) Salaries to employees, operating expenses, depreciation (for tax purposes) and interest paid on loan are the explicit costs to Mary.

The income foregone by not working with Piedmont Properties and cost of actual depreciation comprise implicit costs for Mary.