Until recently, you worked for a software development firm...

Until recently, you worked for a software development firm at a yearly salary of $\$ 35,000 .$ Now, you decide to open your own business. You quit your job, cash in a $\$ 10,000$ savings account (which pays 5 percent interest $),$ and use the money to buy computer hardware to use in your business. You also convert a basement apartment in your house, which you have been renting for $\$ 250$ a month, into a workspace for your new software firm. You lease some office equipment for $\$ 3,600$ a year and hire two part-time programmers, whose combined salary is $\$ 25,000$ a year. You also figure it costs around $\$ 50$ a month to provide heat and light for your new office. a. What are the total annual explicit costs of your new business? b. What are the total annual implicit costs? c. At the end of your first year, your accountant cheerily informs you that your total sales for the year amounted to $\$ 55,000 .$ She congratulates you on a profitable year. Are her congratulations warranted? Why or why not?

Until recently, you worked for a software development firm at a yearly salary of $\$ 35,000 .$ Now, you decide to open your own business. You quit your job, cash in a $\$ 10,000$ savings account (which pays 5 percent interest $),$ and use the money to buy computer hardware to use in your business. You also convert a basement apartment in your house, which you have been renting for $\$ 250$ a month, into a workspace for your new software firm. You lease some office equipment for $\$ 3,600$ a year and hire two part-time programmers, whose combined salary is $\$ 25,000$ a year. You also figure it costs around $\$ 50$ a month to provide heat and light for your new office.
a. What are the total annual explicit costs of your new business?
b. What are the total annual implicit costs?
c. At the end of your first year, your accountant cheerily informs you that your total sales for the year amounted to $\$ 55,000 .$ She congratulates you on a profitable year. Are her congratulations warranted? Why or why not?

Key Concepts

Explicit Costs

Explicit costs refer to the direct, out-of-pocket payments a firm makes during its operations. These include actual cash expenditures such as wages, rents, utilities, and payments for supplies or services. In any business, explicit costs are recorded in the financial accounting records and are relatively straightforward to measure, counting all costs that involve a cash transaction.

Implicit Costs

Implicit costs represent the opportunity costs of using resources that the owner already owns in the business, rather than using them in their next best alternative. These are non-monetary costs and do not involve an actual cash expenditure. They include losses like foregone interest income from saved funds or alternative rental income from using a property for personal business purposes instead of leasing it out.

Opportunity Costs

Opportunity cost is the benefit that is missed or foregone when choosing one alternative over another. It is a key concept in economics that includes both explicit and implicit costs. By considering opportunity costs, one evaluates what is sacrificed in favor of a particular decision, providing a more comprehensive view of the true cost of a decision.

Economic Profit

Economic profit takes into account both explicit and implicit costs, contrasting with accounting profit, which only considers explicit costs. Economic profit is determined by subtracting both types of costs from total revenue, thereby capturing the full cost of foregone opportunities. It offers a more accurate reflection of a business’s financial performance and sustainability over time.

Transcript

00:02 Hello, so in this video, we are going to look at whether or not it is worthwhile to quick a software development company job to start your own business.

00:17 Suppose that you work for a software development firm at a yearly salary of $35 ,000, and you decided to open your own firm.

00:28 And to open your own firm, you cash in your savings of $10 ,000, which could earn 5 % interest per year.

00:40 And you converted your basement for your office space, and you were renting the basement at $250 per month.

00:53 And you rented some equipment for your company at $3 ,000.

00:58 $3 ,600 per year and you hired two programmers to work for you and the total combined salary that you pay for them is $25 ,000.

01:09 And you know that to provide heat for your basement, it will cost you $50 ,000 per month.

01:18 And we want to know first, what are the total annual explicit cost of your new business? so explicit costs are the actual money that you spend to open your business, right? so i will use e to denote which line of the list of the spending you make is explicit.

01:39 You first use your cash in your savings to buy equipment.

01:44 So this is the $10 ,000 is explicit cost.

01:48 You are not renting your own basement.

01:53 So it is, so this rent is not.

01:56 An explicit cost.

01:58 You rent for equipment that's $3600.

02:02 That's its price cost.

02:04 You pay in salaries, that's explicit cost.

02:07 And you're going to provide heat as $50 per month...