John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense - Amount
Labor $2,000
Food and drink 500
Electricity 100
Vehicle lease 150
Rent 500
Interest on loan for equipment 1,000

a. Calculate John's annual accounting profit. $ .
b. Suppose John could earn $1,000 per year as a recycler of aluminum cans, but he prefers to run the café. In fact, he would be willing to pay up to $275 per year to run the café rather than to recycle. Is the café making an economic profit?

(Yes/No) the café is making an economic (profit/loss) of $ ___ per year.

Should John stay in the café business? __

c. Suppose the café's revenues and expenses remain the same, but recyclers' earnings rise to $1,100 per year. Is the café making an economic profit?

(Yes/No), the café is making an economic (profit/loss) of $ per year
Should John stay in the café business?

d. Suppose John had not had to get a $10,000 loan at an annual interest rate of 10 percent to buy equipment, but instead had invested $10,000 of his own money in equipment.

Calculate John's annual accounting profit. $

e. As in part b, suppose John could earn $1,000 per year as a recycler and he has to pay $1,000 per year in interest on his loan, but, unlike part b, suppose John likes recycling just as well as running the café.

How much additional revenue would the café have to collect each year to earn a normal profit? $

a.) $750

b.) Yes, the café is making an economic profit of $25 per year.

Yes, he should stay in the café business.

c.) No, the café is making an economic loss of $75 per year

No, he should not stay in the café business.

d.)$3,250

e.) $250

Explanation:

a) John's accounting profit is his revenue minus his explicit costs:$5,000 - $4,250 = $750

b) In this case, John's opportunity cost of running the café is $725 per year ($1,000 − $275 = $725). Thus, the café is making an economic profit of $25 per year ($5,000 − $4,250 − $725 = $25). Since the café is earning an economic profit, John should stay in the café business.

c) In this case, John's opportunity cost of running the cafe is $825 per year ($1,100 − $275 = $825). Thus, the cafe is earning an economic loss of $75 per year ($5,000 − $4,250 − $825 = −$75). Since the café is earning an economic loss, John should not stay in the café business.

d) John's accounting profit equals his revenue minus his explicit costs. If he doesn't need a loan, then his explicit costs equal $3,250. So, his accounting profit equals $1,750 (= $5,000 − $3,250).

e) To earn a normal profit, the café would have to cover all its implicit and explicit costs. The opportunity cost of John's time is $1,000 per year while the café's accounting profit is only $750 per year. Thus, the café would have to earn additional revenues of $250 per year in order for John to make a normal profit.

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