After graduation you face a choice. One option is to work for a highly regarded consulting firm and earn a starting salary (benefits included) of $55,000. The other option is to use $12,000 you have in savings to start your own consulting firm. Assume you are earning an annual return of 5 percent on your savings. You choose to start your own consulting firm. At the end of the first year, you add up all of your expenses and revenues. Your expenses include $18,000 in rent, $1,000 in office supplies, $50,000 for office staff, $20,000 for your own salary, and $4,000 in telephone expenses. Revenues totaled $147,600. Based on the information provided, what were your total explicit costs? Your implicit costs? What was your accounting and economic profit this first year?

(a) $93,000

(b) $55,600

(c) $54,600

(d) -$1,000

Explanation:

An explicit cost refers to the costs that are incurred to run a business such as rent, wages and materials.

Explicit costs:

= Rent + supplies + Office staff + salary + Telephone expenses

= $18,000 + $1,000 + $50,000 + $20,000 + $4,000

= $93,000

Implicit cost is also known as opportunity costs.

Implicit cost:

= (Amount of saving × Rate) + Salary from consulting firm

= ($12,000 × 0.05) + $55,000

= $600 + $55,000

= $55,600

Accounting profit = Revenues - Explicit cost

                             = $147,600 - $93,000

                             = $54,600

Economic profit = Accounting profit - Implicit costs

                           = $54,600 - $55,600

                           = -$1,000

Explicit Costs = $ 73000 ; Implicit Costs = $ 67600

Accounting Profit = $ 74600 ; Economic Profit = $ 13000 loss

Explanation:

Explicit Costs are real cash outflow expenses, paid for hiring productive factor inputs from outside. Implicit Costs are imputed costs of entrepreneur provided unpaid productive factor inputs  and opportunity cost of money & time invested in business.  

Accounting Profit is excess of Total Revenue over all Explicit Costs. Economic Profit is excess of Total Revenue over Total Explicit & Implicit costs.

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