Imagine the following scenario and answer the questions below; You\'re a constru
ID: 1190336 • Letter: I
Question
Imagine the following scenario and answer the questions below; You're a construction worker earning $40,000 per year. You are very skilled and believe that you can make more by becoming an entrepreneur and starting your own construction company. You have saved up $100,000 and will apply it tow ard the purchase of some initial capital. Currently it is in the bank earning 5% annual interest. After putting together your business plan and speaking with your bank you determine the following: Based on your credit history, work experience, they can loan you $2,300,000 at 5% interest to acquire additional capital. You can build 7 homes in a year with this amount of capital. It will require 48 workers (ft $20,000 annual salary per worker. Each home will require $20,000 in natural resources to construct. The present condition of the real estate market will allow you to sell each home for $200,000 each What are your explicit costs? What are your implic it costs? What is your total opportunity cost? ) Identity- your total cost from the peispective of the accou nt "accounting cost" Identify- your total cost from the perspective of the economist "economic cost" Identify your total revenue Identify your profit from the perspective of the accountant "accounting profit" Identify your profit from the perspective of the economist "economic profit" Should you start the bu siness? why? What if market conditions cause home prices to decrease to $160,000? Reevaluate At what market price would you make a normal profit? What if you are a physician who makes $180,000 per year? Re-evaluateExplanation / Answer
1) Explicit costs would be equal to the total amount paid to external parties. In this case explicit costs would be equal to amount paid to bank as interest + Total salaries of workers + Total price paid for natural resources= 5 % of $23,00,000 + 48 * $ 20,000 + $ 20,000 * 7 = 115000+ 9,60,000+ 1,40,000 = $12,15,000
2) Implicit costs are nothing but the opportunity cost of the investment in its next best alternative. Here, Implicit costs would be equal to annual salary as a construction worker + 5 % interest on owner's capital = $ 40,000 + $ 5 % of $ 1,00,000 = 40,000+5000= $45,000
3) Opportunity costs are same as implict costs which are already calculated above i.e. $ 45,000
4) Accounting costs are same as explicit costs which are calculated above i.e. $ 12,15,000
5) Economic Cost is the sum of both explicit costs and implicit costs i.e $ 45,000+ $ 12,15,000= $12,60,000
6) Total Revenue = number of houses * selling price of each house, which is equal to 7* $ 2,00,000 = 14,00,000
7) Accounting Profit = Total revenue- Accounting Cost. i.e. $ 14,00,000- $ 12,15,000 = $1,85,000
8) Economic Profit = Total Revenue- Economic Costs i.e. $ 14,00,000 - $12,60,000= $1,40,000
9) yes, because the opportunity cost is lower than the profit earned from the business. There is a positive economic profit of $ 1,40,000
10) If value of houses reduce to $ 1,60,000, then new Total Revenue would be = $ 1,60,000*7= $11,20,000. Due to this there would be an economic loss of $ 1,40,000 ( $ 12,60,000- $ 11,60,000). Hence, it is not advisable to start business in such a situation
11) Normal profit occurs when Total Revenue are equal to total costs. Hence, if we assume market price to be x, 7x = 12,15,000
hence x= $1,73,571 (aaprox)
12) If I am a physician who makes $ 1,80,000, the new opportunity cost would be equal to $1,80,000 + 5 % of $1,00,000= $1,85,000. Hence, economic costs would be 1,85,000 + 12,15,000= $14,00,000. Since my revenue from selling 7 houses is also $ 14,00,000. I will only make normal profits. Hence I am indifferent towards starting the business