Chapter 14, Problem 1SPPA

To determine

The income of other entrepreneurs in the shoe shine business = $10,000

Joe's rent payment = $2,000 a year

Joe's revenue = $15,000 a year. He borrowed $1,000 at 20% interest rate to buy equipments.

At the end of one year, he was offered $500 (for business and equipment). Determine annual explicit costs, implicit costs and economic profit.

Explanation of Solution

Joe's annual explicit costs are given below:

  $\begin{array}{l}\text{= Annual Rent payment + Borrowed money with interest rate}\\ \text{= \$2,000 + (\$1,000 + \$1,000}\times 0.\text{20)}\\ \text{= \$2,000 + \$1,200}\\ \text{= \$3,200}\end{array}$

Joe's annual implicit costs are given below:

  $\begin{array}{l}\text{= Normal profit + Amount offered to Joe at the end of an year}\\ \text{= \$10,000 + \$500}\\ \text{= \$10,500}\end{array}$

Therefore, Joe's economic profit for the year is given below:

  $\begin{array}{l}\text{= Total Revenue - Total Costs}\\ \text{= \$15,000 - (Implicit Costs + Explicit Costs)}\\ \text{= \$15,000 - (\$10,500 + \$3,200)}\\ \text{= \$15,000 - \$13,700}\\ \text{= \$1,300}\end{array}$

Economics Concept Introduction

Implicit Costs: The implicit cost is also called imputed cost or indirect cost. Implicit costs are the opportunity costs in the production, which means it measures the cost of giving up an input in order to use another input in the production process.

Explicit Costs: The explicit cost is a direct cost and known as out of pocket costs. It involves the expenditure done on the use of inputs in the production process by a firm.

  $\text{Economic Profit: Total Revenue – Total costs }\left(\text{= Explicit costs + Implicit Costs}\right)$