Freddie quits his job as an airline pilot and opens his own pilot trainning scho

Question

Freddie quits his job as an airline pilot and opens his own pilot trainning school. He was earning $40,000 as a pilot. He withdraws $10,000 from his savings where he was earning 6 percent interest and uses the money in his new business. He uses a building he owns as a hanger and could rent it out for $5,000 per year. He rents a computer for, $1,200, buys office supplies for $500, rents an airplane for $6,000, pays $1,300 for fuel and maintenance, and hires one worker for $30,000. Freddies total revenue from pilot trainning classes equaled $90,400; Freddies implicit costs for this year are equal to:

(A)$55,000

(B)$84,400

(C)$39,000

(D)$45,600

Explanation / Answer

Implicit cost refers to the cost of owner supplied resources.

In the given case, Freddie (the owner) is providing capital, building, and his own labor to the firm.

So, cost pertaining to these three resources is the implicit cost.

Freddie has invested $10,000 of his own funds in business. These could have earned 6 percent interest if invested elsewhere. So, foregone interest is the cost of capital supplied by Freddie.

Foregone interest = $10,000 * 0.06 = $600

He owns the building from which he runs his business. If he was not running the business, he could have rent out the building for $5,000 per year. So, this foregone rent is the cost pertaining to building.

Freddie is devoting time in his own business. Instead of running his own business, if Freddie seeks employment he can get $40,000 as salary. This imputed salary is the cost of his own labor devoted to firm.

Calculate Implicit Cost -

Implicit Cost = Foregone interest + Foregone rent + Imputed salary

Implicit Cost = $600 + $5,000 + $40,000

Implicit Cost = $45,600

Hence, the correct answer is option (D).

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