Managerial Economics.

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Benedictine University

Managerial Economics

Individual Work-1

Unit Tutor: Char Lee Racine
Student name:Gu Haizhen (Vivian)
Date of issue: September 6, 2010
Date of submission: September 13, 2010

Contents

I.3
II.4
III.7
VI.9

Technical problems

I.

During a year of operation, a firm collects $175,000 in revenue and spends $80,000 on raw materials, labor expense, utilities, and rent. The owners of the firm have provided $500,000 of their own money to the firm instead of investing the money and earning a 14 percent annual rate of return.

a. The explicit costs of the firm are $80,000. The implicit costs are $70,000. Total economic cost is $150,000. b. The firm earns economic profit of $25,000.
c. The firm’s accounting profit is $95,000.
d. If the owners could earn 20 percent annually on the money they have invested in the firm, the economic profit of the firm would be $ - 5,000 (when revenue is $175,000).

a. Explicit cost (market – supplied resources) = $80,000
Implicit cost (owner – supplied resources) = 50,000 * 14% = $70,000 Total economic cost = explicit cost + implicit cost = $150,000

b. Economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost = 175,000 – 150, 000 = $25,000

c. Accounting profit = total revenue – explicit cost
= 175,000 – 80,000 = $95,000

d. Economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost = 175,000 – 80,000 – 500,000 * 20% =$ - 5,000

Applied problems

II.

At the beginning of the year, an audio engineer quit his job and gave up a salary of $175,000 per year in order to start his own business, Sound Devices, Inc. The new company builds, installs, and maintains custom audio equipment for business that requires high-quality audio systems. A partial income statement for Sound Devices, Inc., is shown below:

Revenue 2007 Revenue from sales of product and services…………………………$970,000 Operating costs and expenses
Cost of products and services sold……………………………………355,000 Selling expenses……………………………………………………….155,000 Administrative expenses …………………………..…………………..45,000 Total operating costs and expenses…………………………………$555,000 Income from operations……………………………………………….... $415,000 Interest expense (bank loan)……………..………………………………45,000 Legal expenses to start business…………………………………………28,000 Income taxes……………………………………………………………..165,000 Net income………………………………………………………………. $177,000

To get started, the owner of Sound Devices spent $100,000 of his personnel savings to pay for some of the capital equipment used in the business. In 2007, the owner of Sound Devices could have earned a 15 percent return by investing in stocks of other new businesses with risk levels similar to the risk level at Sound Devices. a. What are the total explicit, total explicit, and total economic costs in 2007? b. What is accounting profit in 2007?

c. What is economic profit in 2007?
d. Given your answer in part c, evaluate the owner’s decision to leave his job to start Sound Devices. a. Explicit cost = total operating cost and expenses = $555,000 Implicit cost = 100,000 * 15% = $15,000

Total economic cost = explicit cost + implicit cost
= 555,000 + 15,000 = $570,000

b. Accounting profit = total revenue – explicit cost
= 970,000 – 555,000 = $415,000

c. Economic profit = total revenue – total economic cost
= total revenue – explicit cost – implicit cost =970,000 – 555,000 – 15,000 = $400,000

d. According to the accounting profit and economic profit can understand that it is correct for this audio engineer to give up a salary of $175,000 per year in order to start his own business, the profit he earns...
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