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 for Joe's computer software business is \$65,000 and the economic cost is \$139,000.

Step-by-step solution

Identify the Accounting Cost

The accounting cost is the total expense Joe incurred in the first year. Because he paid a salary to himself of \$40,000 and had other expenses of \$25,000, the accounting cost totals \$40,000 + \$25,000 = \$65,000.

Identify the Opportunity Cost

Joe quit his job which was paying him \$50,000 per year, and he was also earning \$24,000 per year from renting out the building which he now uses for his own business. Hence, the opportunity cost is the sum of these two amounts, \$50,000 + \$24,000 = \$74,000.

Calculate the Economic Cost

The economic cost is the sum of the accounting cost and the opportunity cost. Therefore, it can be calculated as \$65,000 + \$74,000 = \$139,000.

Key concepts

Accounting Cost

In the world of business, numbers matter. When we talk about accounting cost, we're referring to the actual dollars spent on a business. This includes all expenses that help keep the business running day-to-day. For Joe's software business, this means adding up all the expenses he has to pay.

To find Joe's accounting cost, you look at two main expenses: the salary he pays himself and other operational costs. In Joe's case:

• Salary to himself: \(\\(40,000\)
• Other expenses: \(\\)25,000\)

When you add these together, Joe's total accounting cost is \(\$65,000\).

The key thing to remember is that accounting cost reflects the out-of-pocket payments business owners make. It doesn't consider what they might miss out on by choosing to run the business instead of doing something else, which is where opportunity cost comes in.

Opportunity Cost

Opportunity cost is a bit like the road not taken. It's all the benefits a business owner gives up by choosing one path over another. For Joe, this means figuring out what he lost when he decided to leave his job and use the building he owned instead of renting it out.

Let's break it down:

• Joe's salary from his old job: \(\\(50,000\)
• Income from renting his building: \(\\)24,000\)

These aren't small numbers. When you add them together, Joe's opportunity cost is \(\$74,000\).

Understanding opportunity cost helps us see what's at stake when making business decisions. It's not just the money spent, but also what isn't being earned anymore by switching focus to a new venture.

Microeconomics

Microeconomics is like a magnifying glass over small parts of the economy. It examines how individuals and businesses make decisions about spending and pricing. Joe's situation is a perfect microeconomic study. It focuses on how he chooses to use his resources, like time and property, to run his business.

Microeconomics helps us understand:

• Individual business choices and resource allocation
• Cost analysis (accounting and opportunity)
• Market behavior and personal financial decisions

By looking at how Joe analyzes his costs and decides to start a new business, microeconomics reveals the intricate decision-making processes that affect broader market trends.

These concepts show us that even small decisions can have big impacts on economic outcomes.