QUESTION NO.

Economic Profit

It is the profit in which direct cost is deducted from the revenue; however, it also includes
opportunity cost (the cost of giving up one action for another action). This profit can be
determined by the principles of economics but not by accounting principles. (Kimball, (1998))

Accounting Profit

The net income of a company is known as its accounting profit. The profit is calculated after
deducting various costs and expenses from the company's total revenue as expressed in generally
accepted accounting principles (GAAP). Following costs can be included:

1. Raw materials
2. Inventory for production
3. Cost of transportation
4. Financing cost
5. Realized losses
6. Advertisement cost
7. Cost of production and overheads
8. Selling expenses, etc

Explicit costs are the payments made by the company for these costs in the period, for example,
wages paid to labor or payment made to advertising agencies. This profit is reported on an
annual or quarterly basis and can be used to measure the company's financial performance.
(Ryan, (2007))

Adam's monthly income can be calculated as follows:

Before starting a business:

Rent per month = $1,000

Salary per month = $2,500

After starting business:

Monthly revenue = $10,000

Monthly expenses = $6,000

Interest earned on US Government treasury bonds sacrificed =$1000

Accounting Profit:

Revenue $10,000

Less: Expenses ($6,000)

Profit $4,000

Economic Profit:

Revenue $10,000

Less: Expenses ($6,000)

Opportunity cost ($1,000)

Profit $3,000
QUESTION NO.2

a) Fixed Costs
Fixed cost is a cost that does not change when sale or production units varies. That
means fixed cost does not change when production or sales unit increases or decreases.
It remains the same irrespective of increase or decrease. It means whether the company
produces or sells 1 unit, 10 units, or 1000 units, it will not change. Usually, fixed cost
does not increase, but they can increase when required. For example, when business
activity exceeds its level, then requirement increases; thus, fixed cost increases. Fixed
costs have to be paid whether a business is producing goods. Fixed cost includes rent of
land or building, insurance payments, lease amount, sunk cost, etc
So, Fixed cost=$5,000 (Balinski, (1961))

Sunk Costs

Sunk cost is an irretrievable cost. It means that it is an expense that has been previously
incurred and cannot be reoccupied. It is a type of fixed cost, so it does not change with
an increase or decrease in volume or production units. Investors do not consider an
irrelevant cost in decision-making because it does not affect financial decisions. After
all, they have already been incurred. Research and development is an example of sunk
cost. Other examples include the cost of already purchased machinery, equipment, etc.
Sunk cost=Fixed cost-refundable
=$5,000-$1,000
=$4,000
b) ACME should accept the offer because, after sub-lease, he will get $4,500. Moreover, if
he returns it, he will only get a Refund of $1,000. In this case, there will be a loss of
$4,000.
QUESTION NO.3

Contract

An agreement enforceable by law is a contract. A contract is an agreement that legally binds the
parties. The analysis of the above definition reveals that a contract has the following two
elements:

1) Agreement

2) Enforceability

Every promise and set of promises forming the consideration for each other is an agreement.

Every contract is an agreement, but every agreement is not always a contract. An agreement
creating a legal obligation is said to be enforceable by law. The parties to an agreement must be
bound to perform their promises and intend to use them in case of default. For an agreement to
be enforceable by law, there should be legal obligation instead of social, moral.

Spot Exchange

A relationship where customer and supplier are unaware of each other. Both parties are not
legally bound to fulfill their duties when buyer and seller are anonymous and go their separate
ways after doing business and have no formal relationship.

The benefit:
The firm gets to specialize in what they are good at (converting input to output), and the other
party does what they are best at - producing input.

Vertical Integration

Vertical integration is when a firm produces its raw materials to produce its final products. In
vertical integration, the company brings the previously outsourced operations back, and the
operations are extended within the firm's supply chain. The directions of vertical integration can
be forward (downstream) or Backwards (Upstream). This is achieved when the company
develops an extended production line or can be achieved by acquiring vertically. (Perry, 1989)

According to the above data

a) Contract (As the company is legally obligated to purchase chips for the next 3 years)
b) Spot Exchange (As the chips were purchased once and were thereof too)
c) Vertical Integration (As the company is manufacturing its motherboards and computer
chips)
QUESTION NO.4

a)

1) To meet that demand, Jiffy burger needs 2,000 pounds of ground beef delivered to its
premises every Monday morning by 8:00 AM sharp. In spot exchanges, as neither party is
obligated to adhere to specific terms for exchange, there may be a chance that the seller(firm)
does not deliver the order on time, or maybe the seller(firm) back off at the end time, which in
this case could result in loss of profit and also loss of customers.

2) In spot exchange, buyer and seller are anonymous and go their separate ways after doing
business and have no formal relationship (contract), there may be a chance that seller delivers
bad meat or rotten meat, and as they(seller) does not reveal their identity, Jiffy burger franchise
cannot claim for exchange or refund. In this case, they lose their money as well as customers.

b)

1)In spot exchange, an informal relationship is formed between a buyer and seller in which
neither party is obligated to adhere to specific terms for exchange. So, if the seller(firm) sets a
price and at the time of settlement Jiffy burger franchise refuses to pay that amount, the firm
cannot claim legally for their money and suffer a loss.

2) In spot exchange, as buyer and seller are anonymous, there may be a chance that the Jiffy
burger franchise refuses to pay the money at the end.
QUESTION NO.5

It is the practice, policy, or art in which anyone tries to take advantage of opportunities or
circumstances without concern for the principles or results. Opportunistic behavior is the
behavior of partnership that motivates the maximization of the economic self-interest and to
give loss to other partners. In the description of this behavior, it is criticized that a person may
take advantage of situations to gain money or power without thinking that their actions are right
or wrong. Supermarkets tend to take advantage of the customers' specialized investment; the
customer may threaten to inform others about their scam or ask them not to buy anything from
the store. In this situation, the extra small amount earned by them will result in their business
loss in the future. There is an implicit agreement between the parties, which is not enforceable.

By law but is enforceable by the future actions of the customer. So, if the gains from
opportunistic behavior are small but the cost of making the contract is higher than that, the
formal contract is not required, but it is required if the gains are more significant than the cost of
making a contract. That is why customers do not sign a contract with the supermarket once they
are in there to avoid opportunism (Williamson, 1993)
QUESTION NO.6

1. According to the profit-maximizing rule, the price of a resource must equal its marginal
revenue product in a competitive market. This rule determines the level of employment
MPL (labor) / Price(labor) = MPK (capital) / Price(capital).
According to the data given:
Marginal Product of Labor = MPL = 50
Wage Rate = PL = $25
Marginal Product of Capital = MPK = 100
Rental Price of Capital = PK = $40
So,
Marginal Product of Labor / Wage Rate MPL/PL = 50/25 = 2
Marginal Product of Capital / Rental Price of Capital = MPK/PL = 100/40 = 2.5

According to this, MPL/PL is not equal to MPK/PL; Hence the firm is not maximizing profit.

2. The firm should increase the amount of labor's wage rate used in its production process
because as comparing both the prices of labor and capital, the labor is more expensive
than capital, and the marginal product of labor is 50 units of output per hour which are
more than marginal product of capital. Hence, if the firm decreases the amount of wage
rate used in its production process, its production is increased compared to the increase
in the amount of capital. (Primeaux, 1994)
References
Balinski, M. L. ((1961)). Fixed‐cost transportation problems. Naval Research Logistics
Quarterly. 41-54.

Kimball, R. C. ((1998)). Economic profit and performance measurement in banking. . New

England Economic Review, 35-53.

Perry, M. K. (1989). Vertical integration: Determinants and effects. Handbook of industrial

organization. 183-255.

Primeaux, P. &. (1994). Profit maximization: The ethical mandate of business. Journal of
Business Ethics. 287-294.

Ryan, J. ((2007)). The relationship between accounting profit and economic income. Australian
Accounting Review, 17(43), 33-46.

Williamson, O. E. (1993). Opportunism and its critics. Managerial and decision economics. 97-
107.