Question

Suppose a company incurs the following costs: labor, $500; equipment, $300; and materials, $200. The company owns the building, so it doesn?t have to pay the usual $850 in rent. (a) What is the total

Answer 1

(a) Accounting costs occur anytime there is an outlay of money by a firm. In short, anytime a firm has to pay for something, it would be considered an accounting cost. In this problem, the firm is expected to pay for its labor, equipment, and materials, so its total accounting cost is: $500 + $300 + $200 = $1000. Note that the rental value of the building is not considered an accounting cost because the firm owns the building.

(b) To calculate the total economic cost, we must consider opportunity costs as well as monetary outlays by the firm. The firm's opportunity cost can be seen as what it gives up by operating. In this example, the firm forgoes $850 in rent by choosing to operate in the building, so we add this rental value to our accounting costs in (a) to find that the total economic cost for our firm is: $1000 + $850 = $1850.

(c) Notice that if the firm sold the building and then leased it back, the rental value of $850 would be considered an accounting cost. The total accounting cost would rise to $1000 + $850 = $1850. Since there are no opportunity costs in this case, the total economic cost is equivalent to the total accounting cost.