1. Explicit vs. Implicit costs
According to your textbook, explicit costs are "tangible out-of-pocket expenses;" whereas, implicit costs "are the opportunity costs of doing business." That is if you actually pay out money something such as rent, raw materials, labor costs, etc. they are explicit costs. If you are giving up something such as wages forgone, interest foregone they are implicit costs. (see table 8.1 on page 244) Accountants look only at explicit costs when determining profit. Eonomists consider implicit costs as well. Thus:
Accounting profit = Total Revenue - explicit costs
Economic Profit = Total Revenue - (explicit + implicit costs)
Given this information and the following data answer questions a-e.
Teresa has a shoe factory. She owns the building that the factory is in. If she rented it out rather than using it to produce shoes she could get $50,000 per year in rent. Teresa has labor costs of $300,000 per year and raw materials cost her $200,000 per year. She pays $25,000 in advertising each year. If Teresa was not producing shoes she could work as a manage at the Nike factory and make $110,000 per year. Teresa used up her savings to start the shoe factory forgoing $50,000 in interest she would have received.
a. What are the explicit costs of this factory?
b. What are the implicit costs?
c. If Teresa has total revenue of $600,000, what is the accounting profit?
d. If Teresa has total revenue of $600,000, what is the economic profit?
e. If Teresa was a rational producer, should she continue producing shoes? Why or why not?