Question

PLEASE HELP!!!!

Leo is deciding if he wants to start his own business. Currently he works for a large bank as a financial analyst and earns $55,000/year. He also owns a small two-bedroom townhouse, but a friend lives in the second bedroom and pays $600/month rent. If Leo starts his new business as a freelance analyst selling his services to some of his corporation’s current clients, he will need to buy a laptop computer for $1200 and will spend another $2000/year on travel expenses and supplies for his new business. He expects his new business will earn $70,000 per year, but it could be a lot higher or lower, and he expects to work harder, working 10 hours more per week. Finally, when he starts his new business, he will ask his roommate to leave so he can use the second bedroom as a workroom. Otherwise, all of his spending will be the same under both options.

For parts A-E, focus only on the dollar numbers that are quantified in the problem. Do not consider the factors that cannot accurately be quantified – only consider the factors that are numerically quantified. So don’t make the problem more difficult than it is! Leave that for parts F and G.

A.What is Leo’s explicit costs of his new business over the next year?

B.What is Leo’s implicit cost of his new business over the next year?

C.What is Leo’s economic cost of his new business over the next year?

D. What is Leo's expected economic profit from his new business over the next year?

E. Based on your answer to #4, should Leo start his new business?

F. What factors cannot easily be quantified, but Leo might want to consider them when making his decision?

G. Would the factors in F change your decision in E, if you were Leo? (Note that there is no numeric answer to this since the factors can’t be quantified precisely. Nonetheless it is that way with many decisions we make in real life, and we need to consider them nonetheless and do the best we can.)

Answer 1

Solution:

A. Explicit cost is the expense a firm incurs in purchasing or hiring the factor services.Hence, Leo's explicit costs are:

Explicit cost = $1200 + $2000 = $3200

B. Implicit cost is the estimated value of inputs owned by the firm and used by it in its own production

Leo's implicit cost = The money value of the small two-bedroom townhouse which Leo owned.

C. Economic cost is the sum of explicit cost and implicit cost (including normal profit).

Economic cost = explicit cost + implicit cost including normal profit

=  $3200 + money value of two-bedroom   townhouse owned by Leo including normal profit .

D. Economic cost = Total Revenue - (Explicit cost + Implicit cost)

= $70,000 - ($3200 + money value of two-bedroom townhouse owned by Leo )