Managerial Economics Question Set Before

Managerial Economics Question Set

Before Sarah quit her job as a carpenter, she was earning $35,000 per year. She rented a building for $12,000 per year and opened a cabinet shop. She spends $148,000 per year for labor, materials, utilities, and advertising.

(i) How much revenue will the business have to earn in order to break even in terms of business profit?

If Sarah's expenses for rent, labor, materials, utilities, and advertising are equal to $160,000 per year, she will need to earn at least $160,000 in her first year of operation to break even in terms of business profit. If Accounting Profit = Total Income -- Total Expenses, then Sarah would need a Total Income of ($160,000), before subtracting Total Expenses ($160,000), to reach the break-even point in terms of business profit.

(ii) How much revenue will the business have to earn in order to break even in economic terms?

In this scenario, Sarah's economic profit will be based on the concept of Opportunity Cost Lost, which measures the effect of investment choices on overall income. Sarah's previous job as a carpenter represented a "profit" of $35,000 annually, but by choosing to quit that job before opening her own business, Sarah has effectively forgone the potential profit from this "investment." If Economic Profit = Total Income -- Total Expenses -- Opportunity Lost Cost, Sarah would need a Total Income of ($195,000), before subtracting Total Expenses ($160,000), and Opportunity Cost Lost ($35,000) to reach the break-even point in terms of economic profit. Using only the business profit accounting method, Sarah's failure to retain her day job has no impact on her bottom line, but applying the economic profit accounting method means she needs to earn an additional $35,000 simply to break-even.

(iii) Suppose that Sarah buys the building. Now how much will the business have to earn in order to break even in economic terms?

This question is impossible to answer without knowing the purchase price Sarah paid for the building, as this figure is crucial to calculating the economic profit formula. No matter the exact figure, however, Sarah would have to earn an additional amount equal to the difference between renting an buying the building, as both options represent divergent investment strategies.

2.) According to Milton Friedman, "Business has only one social responsibility, to make profits (as long as it stays within the legal and moral rules of the game established by society). Few trends could so thoroughly undermine the very foundations of our society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible." Explain why you agree with such a statement.