Question

One year ago, Jack and Jill set up a vinegarbottling firm (called JJVB). Use the following data to calculate JJVB's opportunity cost of production during its first year of operation: Jack and Jill put \(\$ 50,000\) of their own money into the firm and bought cquipment for \(\$ 30,000\) They hired one worker at \(\$ 20,000\) a year. Jack quir his old job, which paid \(\$ 30,000\) a year, and worked full-time for JJVB. : Jill kept her old job, which paid \(\$ 30\) an hour, but gave up 500 hours of leisure a year to work for JJVB. I JVB bought \(\$ 10,000\) of goods and services. The market value of the cquipment at the end of the year was \(\$ 28,000\) ack and Jill have a \(\$ 100,000\) home loan on which they pay interest of 6 percent a year.

Short answer

JJVB's opportunity cost of production during its first year of operation is \(\$80,000\).

Step-by-step solution

- Calculate the explicit costs

Explicit costs are the direct, out-of-pocket expenses. These include the costs of goods and services, the worker's salary, and the depreciation on the equipment. - Salary for the worker: \(\$20,000\) - Costs of goods and services: \(\$10,000\) - Depreciation of equipment: The equipment's value decreased from \(\$30,000\) to \(\$28,000\), so depreciation is \(\$30,000 - \$28,000 = \$2,000\) Adding these together gives the total explicit costs: \(\$20,000 + \$10,000 + \$2,000 = \$32,000\)

- Calculate Jack's opportunity cost

Jack's opportunity cost includes the earnings he forwent by quitting his old job to work full-time for JJVB. - Jack's forgone salary: \(\$30,000\)

- Calculate Jill's opportunity cost

Jill's opportunity cost is the income she could have earned if she had used her 500 hours of leisure time working at her old job. - Jill's forgone earnings: \(30 \, \text{dollars/hour} \times 500 \, \text{hours} = \$15,000\)

- Calculate the opportunity cost of the invested money

The \(\$50,000\) Jack and Jill invested in the firm could have earned interest if it had been used elsewhere. Assuming the interest rate is similar to what they pay for their home loan: \[\text{Opportunity cost of invested money} = \$50,000 \times 0.06 = \$3,000\]

- Total opportunity cost of production

Sum all opportunity costs (explicit costs, Jack's forgone salary, Jill's forgone earnings, and opportunity cost of invested money): \[\text{Total opportunity cost} = \$32,000 + \$30,000 + \$15,000 + \$3,000 = \$80,000\]

Key concepts

Explicit Costs

Explicit costs refer to direct, out-of-pocket expenses paid by the business. For Jack and Jill's vinegar-bottling firm (JJVB), these costs include:

• \$20,000\ salary for the worker.
• \$10,000\ for goods and services.
• Depreciation of equipment: \( \$2,000\ \) because the value of the equipment fell from \$30,000\ to \$28,000\.

Adding these expenses gives total explicit costs of \( \$20,000\ + \$10,000\ + \$2,000\ = \$32,000\ \). These are the direct financial costs JJVB incurred during its first year of operation.

Forgone Salary

Forgone salary is an example of an implicit cost. These costs represent what an individual has sacrificed in terms of income. For JJVB, Jack's forgone salary comes into play:
Jack left his old job, which paid \$30,000\ a year, to work full-time at JJVB.
This lost income, \( \$30,000\ \), is considered an opportunity cost because it's money Jack could have earned if he had stayed at his previous job.

Forgone Earnings

Forgone earnings include income that is sacrificed by choosing one activity over another. In Jill's case:
Although she kept her old job, Jill gave up 500 hours of leisure to contribute to JJVB.
Her old job paid \$30\ an hour, meaning she gave up \( 500 \, \text{hours} \times \$30\/ \text{hour} = \$15,000\ \).
This amount represents Jill's forgone earnings, which is another part of JJVB's opportunity cost.

Depreciation

Depreciation is the loss in value of an asset over time. For JJVB:
The equipment initially purchased for \$30,000\ depreciated to \$28,000\ in one year.

• This represents a depreciation of \( \$30,000\ - \$28,000\ = \$2,000\ \).

Depreciation is a non-cash expense but still an important explicit cost of production.

Investment Opportunity Cost

Investment opportunity cost represents the income lost from not investing money elsewhere. For JJVB:
Jack and Jill invested \$50,000\ of their own money into the firm instead of placing it in an interest-bearing account.
Assuming an interest rate of \( 6 \% \) (similar to their home loan), the opportunity cost is: \[ \$50,000\ \times 0.06 = \$3,000\ \] This \$3,000\ shows the income they missed out on by not investing elsewhere.