AP MicroeconomicsChapter 22Cost of production

  1. Define
  2. Implicit Costs
  1. Explicit Costs
  1. Accounting Profits
  1. Economic Profits

Read the following stories and answer the questions that follow.

II. Jane quit her job at General Motors where she earned $38,000 a year. She cashed in $40,000 in corporate bonds that earned 10% interest annually to buy a small dress shop. Jane values her entrepreneurial ability at $5,000 per year. Jane has decided to buy the dress shop and move back to her hometown. In her first year of operation, she had $150,000 in sales. She spent $75,000 to buy the dress wholesale for the shop and she hired an employee who worked part-time for $15,000 for the year.

1. What are Jane's total revenues? ______

2. What are Jane's explicit costs? ______

3. What is her accounting profit? ______

4. List three implicit costs that Jane has not included?

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5. Why are the costs you listed in part (4) really Jane’s opportunity costs?

6. What is Jane's pure economic profit (or loss)? ______

III. John Doe was employed as plant manager at Dell Computer for a salary of $150,000 per year. He had savings of $100,000 invested in securities that yielded a 6% annual return. John quit working at Dell and opened a computer consulting business, investing all of his savings in the enterprise to rent an office and to buy equipment . At the end of the first year, accounts showed a net income of $200,000 after all expenses of operation. His accountant said this accounting profit represented a 200% return on his investment. Another accountant stated, “You should pay yourself the $150,000 you should have earned anyway, and the $6,000 you would have had on your securities; now, your profit represents only a 44% return on your investment. “

1. What is the accounting profit?______

2. What is the economic profit (or loss)? ______

3. Who was right? The first accountant or the second? Explain.

IV. Now, it’s your turn!

  1. Write a story that employs all the terms and concepts about a firm’s goals of maximizing profits. Be sure to include the following list of terms: Accounting costs and profits, Opportunity costs, explicit and implicit costs, economic profit.
  2. Write set of questions about the terms and concepts that fit the story you have written.
  3. Share your story and questions with another student in your class and see if you can catch them in a mistake about costs and firm goals.

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