Answer to Question #158725 in Microeconomics for ayesha

Question

Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4000 per year if alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3000 per year. Total annual revenue from pottery sales is $72,000. Calculate the accounting profit and the economic profit for Gomez’s pottery firm

Answer 1

For production to occur, explicit costs are incurred by the business, which is mainly paid externally. Implicit costs are opportunity costs that are not monetary payments by the business.

Gomez, in this case, earns total revenue of $72,000. In this case, the explicit costs incurred are wages to the helper, rent, and material expenditure.

Explicit cost=$12,000 + $5000 + $20,000 

=$37,000

Implicit costs, in this case, are forgone interest, forgone wages, and foregone entrepreneurial talents.

Implicit cost= $4000 + $15,000 + $3000 

=$22,000

Calculating the accounting profits is done by subtracting total explicit costs from the total revenue earned.

Accounting profits= TR-Total Explicit Costs

=$72,000-$37,000

=$35,000

Thus Gomez earned $35,000 as the accounting profits.

Calculation of economic profits is done by involving both explicit and implicit costs.

Economic Profits=TR - (Total Explicit Costs + Total Implicit Costs)

=$72,000-($37,000+$22,000)

=$72,000-$59,000

=$13,000

Thus Gomez earned $13,000 as economic profits.