Check Your Understanding

1. Question

   Karma and Don run a furniture-refinishing business from their home. Which of the following represent an explicit cost of the business and which represent an implicit cost?

   1. supplies such as paint stripper, varnish, polish, sandpaper, and so on

      Supplies are an explicit cost because they require an outlay of money.

   2. basement space that has been converted into a workroom

      The inability to use the basement for other purposes is an implicit cost.

   3. wages paid to a part-time helper

      Wages are an explicit cost.

   4. a van that they inherited and use only for transporting furniture

      By using the van for their business, Karma and Don forgo the money they could have gained by selling it. So, the use of the van is an implicit cost.

   5. the job at a larger furniture restorer that Karma gave up in order to run the business

      Karma’s forgone wages from her job are an implicit cost.

2. Question

   1. Suppose you are in business earning an accounting profit of $25,000. What is your economic profit if the implicit cost of your capital is $2,000 and the opportunity cost of your time is $23,000? Explain your answer.

      Economic profit is zero:

      Implicit cost	= $2,000 + $23,000 = $25,000
      Accounting profit	= Total revenue – Explicit cost – Depreciation
      	= $25,000
      Economic profit	= Total revenue – Explicit cost – Depreciation
      	– Implicit cost
      	= Accounting profit – Implicit cost
      	= $25,000 – $25,000 = $0

   2. What does your answer to part a tell you about the advisability of devoting your time and capital to this business?

      An economic profit of zero is considered a “normal profit.” The resources devoted to this business could not earn more if used in the next best activity. This is just enough profit to keep you in this business with no regrets.