Expenses, Revenue and Profits

  1. You are the manager of a small business. Every month, you bring in $22000 in revenues. You work in your business. You could have worked somewhere else for a salary of $6000 per month. Your monthly wage expenses payable to other workers are $12000, and your monthly rent for the business office is $5000. However, you believe that the owner will allow you to be released from your rent for a compensation of $1000 per month remaining on the contract. Your monthly expenses for materials needed for the business are $2000. Your expenses for the business license are $2000 per month. They were already paid for the whole year and cannot be recovered. It is now March.
    1. Calculate expenses, revenues and profits using the accounting method (assuming the business keeps operating)
    2. Repeat (a) using the economic method (assuming the business keeps operating)
    3. Should you continue operating the business until the end of the year? You may assume no change is going to affect the income and expense streams – i.e. there is no uncertainty.
    4. Should you continue operating the business next year? You may assume no change is going to affect the income and expense streams – i.e. there is no uncertainty.
  2. Explain the difference between the economic and accounting methods of measuring costs, revenues, and profits. Explain what each of these systems is useful for, and when conclusions drawn from it may be misleading.
  3. Describe, in one paragraph each, the three most important, highly applicable to management, lessons you learned from this class. There is more than one right answer. This question is merely meant to make you reflect and think again about the class, what you got from it, and what you should focus on remembering and using.
  4. Explain why it is customary for manufacturers to offer warranties although doing so costs money. Hint – think about uncertainty and risk.
  5. You are the owner of a competitive firm. Prices of labor and capital are $1 each. The production function is F(L,K)=L^0.25*k^0.25
    1. calculate how many units of K and L you need to produce 100 units of product optimally (i.e. while minimizing costs), and what is your expenditure on inputs
    2. calculate total costs as a function of the quantity produced.
    3. calculate marginal costs, and find the optimal quantity to produce if market price is given by $100.
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