Question

Jamie is considering leaving her current job, which pays \(75.000 per year, to start a new company that develops applications for smart phones. Based on market research, she can sell about 50.000 units during the first year at a price of \)4 per unit. With annual overhead costs and operating expenses amounting to $145,000, Jamie expects a profit margin of 20 percent. This margin is percent larger than that of her largest competitor, Apps, Inc.

a. If Jamie decides to embark on her new venture, what will her accounting costs be during the first year of operation? Her implicit costs? Her opportunity costs?

b. Suppose that Jamie’s estimated selling price is lower than originally projected during the first year. How much revenue would she need in order to earn positive accounting profits? Positive economic profits?

Short answer

a. The accounting cost during the first year of operation is $145,000.

b. The total revenue should be greater than $145,000 in order to earn a positive economic cost.

Step-by-step solution

(a) Determining the accounting cost

The accounting costs are the costs most often associated with the costs of producing.

For example, accounting costs include direct payments to labor and capital to produce output. In this situation described in the task, the accounting costs during the first five years are $145,000.

(b) Determining the revenue she need to earn positive accounting profits

The accounting profit is the total amount of money taken in from sales minus the dollar cost of producing goods or services. That is:

$AP=TR-EC$

Where AP represents accounting profit, TR is total revenue, EC is explicit cost.

As Jamie’s explicit cost is $145,000, it follows that his total revenue should be greater than $145,000 in order to earn a positive accounting profit.

The economic profits are the difference between the total revenue and the total opportunity cost of producing the firm’s goods or services, where the opportunity cost of using a resource includes both the explicit and the implicit cost, that is:

$EP=TR-EC-IC$

EP is economic profits, TR is total revenue, EC is explicit cost and IC is implicit cost.

As Jamie’s opportunity cost is $220,000, it follows that his total revenue should be greater than $145,000 in order to earn a positive economic profit.