Question

Linda sells 100 bottles of homemade ketchup for \(\$ 10\) each. The cost of the ingredients, the bottles, and the labels was \(\$ 700 .\) In addition, it took her 20 hours to make the ketchup and to do so she took time off from a job that paid her \(\$ 20\) per hour. Linda's accounting profit is ______ while her economic profit is _____. a. \(\$ 700 ; \$ 400\) b. \(\$ 300 ; \$ 100\) c. \(\$ 300 ;\) negative \(\$ 100\) d. \(\$ 1,000 ;\) negative \(\$ 1,100\)

Short answer

The answer is c. $300 ; negative $100.

Step-by-step solution

Calculate Revenue

Linda sells 100 bottles of ketchup at a price of \(10 each. To find the total revenue, multiply the number of bottles by the price per bottle: Revenue = 100 bottles \( \times \) \)10 = $1000.

Determine Total Explicit Costs

The explicit costs include the cost of ingredients, bottles, and labels, which is given as $700. Additionally, the explicit cost does not include Linda's lost wages at this step, as they are considered implicit.

Calculate Accounting Profit

Accounting profit is calculated by subtracting explicit costs from the revenue: Accounting Profit = Revenue - Explicit Costs Substitute the values: Accounting Profit = $1000 - $700 = $300.

Calculate Implicit Costs

The implicit costs include Linda's lost wages from taking time off her job. She took 20 hours off, and her job pays \(20 per hour. So, her lost wages are:Implicit Costs = 20 hours \( \times \) \)20/hour = $400.

Compute Economic Profit

Economic profit is calculated by subtracting both explicit and implicit costs from revenue: Economic Profit = Revenue - (Explicit Costs + Implicit Costs) Using our figures: Economic Profit = $1000 - ($700 + $400) = $1000 - $1100 = -$100.

Select the Correct Answer Choice

Based on the calculations: - Accounting profit is $300. - Economic profit is negative $100. - The correct answer choice is c. $300 ; negative $100.

Key concepts

Accounting Profit

When businesses look at their profitability, one of the primary metrics used is Accounting Profit. This concept is relatively straightforward. It represents the difference between total revenue and total explicit costs.
Explicit costs are the direct, out-of-pocket payments for the production of goods or services, such as ingredients and materials. In Linda's case, her revenue from selling ketchup bottles totaled \(1,000. Meanwhile, her explicit costs only accounted for \)700, covering expenses like materials and labels.

• **Formula for Accounting Profit:** \[\text{Accounting Profit} = \text{Revenue} - \text{Explicit Costs} \]
• **Example Calculation:** \[\text{Accounting Profit} = \\(1,000 - \\)700 = \\(300 \]

Linda's Accounting Profit is thus \)300, which gives a basic insight into her business success before considering other factors.

Implicit Costs

Implicit Costs are a bit more abstract but are equally critical when calculating overall profitability. These include potential earnings that were foregone by choosing one activity over another. For Linda, these hidden costs are represented by the wages she missed out on while making ketchup instead of working her regular job.

• **Opportunity Cost:** If Linda's job pays \(20 an hour, and she forgoes her job to produce ketchup for 20 hours, her implicit costs can be calculated. \[\text{Implicit Costs} = 20 \text{ hours} \times \\)20/\text{hour} = \$400 \]
• **Significance:** These costs are vital to consider for full financial assessments, as they impact the overall economic decision-making process.

Recognizing implicit costs helps in understanding that Linda's time has value, even if it isn't paid directly in cash.

Explicit Costs

Explicit Costs are straightforward and often easier to determine than their implicit counterparts. They consist of direct payments made in the course of running a business. In entrepreneurship, these expenses are unavoidable and must be accounted for to assess profitability accurately.
For Linda, her explicit costs included all expenditures directly related to the production of her ketchup.

• **Components:** Costs for ingredients, bottles, and labels amounted to $700.
• **Cost Management:** Ensuring these costs are minimized without sacrificing quality is crucial for maximizing profit.

Understanding these costs optimizes operational processes and ensures the business can operate sustainably without financial strain.

Revenue Calculation

Calculation of Revenue is the first step in determining profitability and involves multiplying the price of goods by the number of goods sold. This straightforward metric gives an initial look at sales success and business growth potential.
In Linda’s business, revenue calculation was simple:

• **Sales Data:** She sold 100 bottles, each priced at \(10.
• **Revenue Formula:** \[\text{Revenue} = \text{Number of Units Sold} \times \text{Price per Unit} \]
• **Example Calculation:** \[\text{Revenue} = 100 \text{ bottles} \times \\)10/\text{bottle} = \$1,000 \]

Understanding how to calculate revenue effectively is crucial for monitoring business performance and forecasting future profit margins.