3. Definition of economic costs Bob lives in Detroit and runs a business that sells pianos. In an average year, he receives $701,000 from selling pianos. Of this sales revenue, he must pay the manufacturer a wholesale cost of $420,000; he also pays wages and utility bills totaling $247,000. He owns his showroom; if he chooses to rent it out, he will receive $9,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Bob does not operate this piano business, he can work as a financial advisor, receive an annual salary of $32,000 with no additional monetary costs, and rent out his showroom at the $9,000 per year rate. No other costs are incurred in running this piano business.

The answer is in the explanation

Explanation:

Explicit cost is the money expenditure incurred by the business owner on inputs or payments made by him to outsiders for purchasing goods or services from them or for hiring their factor services.

Implicit cost is the estimated value of inputs supplied by the owner himself.

In the given case, Bob pays the wholesaler for procuring piano from him for further sale. So, payment made to wholesaler is an explicit cost for Bob.

Bob can earn $32,000 per year if he chooses to work as financial advisor instead of running his own business. Thus, this salary is the estimated value of his own factor services being supplied to his firm and thus is an implicit cost for Bob.

Wages and utility bills paid by Bob are payments made by the Bob to outsiders for procuring factor services or services from them and therefore these expenses are explicit cost for Bob.

In given case, Bob owns the showroom from which he operates. If he chooses to rent it out, he can get $9,000 as rent. So, this estimated rent of own showroom is an implicit cost for Bob.

Calculate Accounting profit of Bob -

Accounting profit = Total revenue - Explicit cost

Accounting profit = Total revenue - (Payment to wholesaler + payment for wages and utility bills)

Accounting profit = $701,000 - ($420,000 + $247,000)

Accounting profit = $701,000 - $667,000

Accounting profit = $34,000

The accounting profit of Bob is $34,000.

Calculate Economic profit of Bob -

Economic profit/loss = Total revenue - Explicit cost - Implicit cost

Economic profit/loss = Total revenue - (Payment to wholesaler + payment for wages and utility bills) - (Implied rent + implied salary)

Economic profit/loss = $701,000 - ($420,000 + $247,000) - ($9,000 + $32,000)

Economic profit/loss = $701,000 - $667,000 - $41,000

Economic profit/loss = - $7,000

Bob will make an economic loss of $7,000.

Economic costs include both accounting and implicit costs (opportunity).

Bob's economic profit/loss = accounting profit - opportunity costs

accounting profit = total revenues - total expenses = $701,000 - $420,000 - $247,000 = $34,000 opportunity costs = lost wages + lost rent = $32,000 + $9,000 = $41,000

Bob's economic loss = $34,000 - $41,000 = - $7,000, if Bob rented the store and worked as a financial adviser he could earn more money.

Opportunity costs are the extra costs or benefits lost from choosing one activity or investment instead of another alternative.