Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 8: Problem 7

Dane decides to give up a job earning \(\$ 200,000\) per year as a corporate lawyer and converts the duplex that he owns into a UFO museum. (He had been renting out the duplex for \(\$ 20,000\) a year.) His explicit costs are \(\$ 75,000\) per year paid to his assistants and \(\$ 10,000\) per year for utilities. Fans flock to the museum to see his collection of extraterrestrial paraphernalia, which he could easily sell on eBay for \(\$ 1,000,000\). Over the course of the year, the museum brings in revenues of \(\$ 200,000\). a. How much is Dane's accounting profit for the year? b. Is Dane earning an economic profit? Explain.

Short Answer

Expert verified
a. Dane's accounting profit for the year is \$115,000. b. No, Dane is not earning an economic profit as it's negative (-\$1,105,000), indicating that he would have been better off financially by not operating the UFO museum and instead working as a corporate lawyer, renting the duplex and selling his collection on eBay.

Step by step solution

01

Calculation of Accounting Profit

Accounting profit is calculated as total revenues minus the explicit costs. Here, the total revenue is given as \$200,000 and explicit costs as (\$75,000 + \$10,000) = \$85,000. Hence, accounting profit = \$200,000 - \$85,000 = \$115,000.
02

Calculation of total implicit costs

The implicit costs include the income foregone from the next best alternative. Here, there are 3 main implicit costs: 1. Dane's forgone salary as a corporate lawyer (\$200,000), 2. Foregone rental income (\$20,000), 3. The alternative cost of selling his collection on eBay (\$1,000,000) So, total implicit cost = \$200,000 + \$20,000 + \$1,000,000 = \$1,220,000.
03

Calculation of Economic Profit

Economic profit is calculated as accounting profit minus the sum of implicit costs. Hence, economic profit = \$115,000 - \$1,220,000 = -\$1,105,000. Economic profit is negative, implying that Dane is not earning an economic profit by running the museum.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Distinguish between a firm's explicit costs and its implicit costs and between a firm's accounting profit and its economic profit.

(Related to the Apply the Concept on page 256) While running for president, former Secretary of State Hillary Clinton published a position paper outlining how, if elected, she would make it easier to start a small business. One of her proposals was: Any state and locality willing to make starting a business cheaper and easier and meaningfully streamline unnecessary licensing programs will receive federal funding to support innovative programs and offset forgone licensing revenue. a. Why might this proposal be expected to increase the rate at which small businesses are formed? b. Given your answer to part (a), why did state and local governments pass such licensing requirements in the first place?

How do the stock and bond markets provide information to businesses? Why do stock and bond prices change over time?

(Related to the Apply the Concept on page 264) A column in the Wall Street Journal listed "trying to forecast what stocks will do next" as one of the three mistakes investors make repeatedly. Briefly explain why trying to forecast stock prices would be a mistake for the average investor.

(Related to the Apply the Concept on page 259 ) According to an article by Reuters News Agency, in November \(2016,\) Fitch Ratings cut its rating on McDonald's bonds from \(B B B+\) to \(B B B\). a. What is Fitch's top bond rating? Under what circumstances would Fitch, or the other bond rating agencies, be likely to cut the rating on a firm's bonds? b. What will be the likely result of this rating's cut for the interest rate McDonald's will have to pay when it sells new bonds? Briefly explain.
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free