(individual) Chuck Waggin owns and operates a small tax-accounting firm, which he runs out of the basement of his home.
- The basement was just wasted space until Chuck turned it into an office for his business. He says his firm is more profitable than most tax-accounting businesses because he doesn't have to pay any rent. Do you agree that rent is not a cost of production for Chuck?
Whether he pays it to someone else, or doesn't rent the space out to someone else, he's still giving up some money. The money lost by not renting the space out may be less than what he'd pay by renting out a
- Chuck recently turned down an offer to go to a work for a larger firm at a salary of $45,000 a year. Chuck's personal income from his business runs about $35,000 a year. Would you say that Chuck's firm is profitable?
Yes. Because not reporting to some corporate schmuck is worth $10K a year easily. I'd still consider it profitable. Just not as profitable as the alternative. It could be considered losing money on the opportunity cost, but it's not how most people understand the term.
- Chuck says he liked being his own boss, and that he would be willing to sacrifice at least $25,000 a year in income to avoid working for someone else Does that information change your answer to part b?
Heh. Apparently not.
- Chuck recently invested $10,000 of his savings in an office comuter. How would you include the effects of this investment in his costs?
Depreciation. While the monetary cost of the computer is incurred all in one swoop, it's really a cost over the life of the computer. The balance isn't a cost, but an asset to be used later. even at the beginning, it's value is more than what he paid for it, so it's really not a net cost. Otherwise, why would he have bought it?
- Chuck could have earned 12 percent per year on his savings had he used them to buy the computer. If he had not had these savings, he still would have bought the computer, using a loan from a bank at 18 percent annual interest to finance the purchase. Is the opportunity cost of owning the computer really less for Chuck because he had savings of his own from which to buy it? If Chuck had been required to pay 18 percent interest to the bank rather than give up 12 percent interest, for what would the additional 6 percent have been a payment? Does Chuck reduce his costs by financing the computer purchase himself?
The addition 6 percent is for the risk that Chuck will default. If he wouldn't have defaulted, it would likely be better off for him to pay for the computer up front. If he would default, it's better to borrow. But even those answers depend. Most likely reason for default is his business isn't doing well. In that case, if he financed it himself, he'd still have a computer to sell, though he'd be out the money. If he borrowed, he's likely to have it repossessed. If he defaults because he takes the computer and runs to Mexico, he's better off for having borrowed the money. In the end, it'd probably be mostly a wash.