Question

Joe quits his computer programming job, where he was earning a salary of \(\$ 50,000\) per year, to start his own computer software business in a building that he owns and was previously renting out for \(\$ 24,000\) per year. In his first year of business he has the following expenses: salary paid to himself, \(\$ 40,000 ;\) rent, \(\$ 0 ;\) other expenses, \(\$ 25,000 .\) Find the accounting cost and the economic cost associated with Joe's computer software business.

Short answer

The accounting cost associated with Joe's computer software business is $65,000 and the economic cost is $139,000.

Step-by-step solution

Calculate Accounting Cost

First, identify the different expenses incurred during the first year of Joe's business. This includes salary paid to himself: \( $40,000 \), rent: \( $0 \) (since he owns the building), and other operating expenses: \( $25,000 \). Add all these expenses to obtain the accounting cost: \( $40,000 + $0 + $25,000 = $65,000 \).

Determine Opportunity Cost

Next, determine the opportunity costs, which refers to the loss of potential gain from other alternatives when one alternative is chosen. In this case, it would be the salary Joe was making at his former job (\( $ 50,000 \)) plus the annual rent he is foregoing by using the building himself instead of renting it out (\( $ 24,000 \)). So, the opportunity cost is: \( $50,000 + $24,000 = $74,000 \).

Calculate Economic Cost

Finally, the economic cost is the total of the accounting cost and the opportunity cost. So, add the accounting cost calculated in Step 1 to the opportunity cost from Step 2 to get the economic cost: \( $65,000 (Accounting Cost) + $74,000 (Opportunity Cost) = $139,000 \).