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Economic and Accounting Cost Functions

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Three University of Florida engineering students are considering operating a mobile car clinic in Gainesville, Florida, during their summer break. This is an alternative to summer employment stacking plastic cups at a local injection molding manufacturer where they would earn $10,000 each over the three-month summer period. A van equipped for such service can be leased at a cost of $5,000 for the summer from an owner taking a long vacation in the Bahamas. Additional projected costs are $2,500 for insurance, and $5 per service call for materials and supplies. Their service calls would be priced at $30 per unit, plus any parts costs (parts will not be inventoried, but purchased from local parts outlets).

A. What is the accounting cost function for this business (ignoring parts)?
B. What is the economic cost function for this business?
C. What is the economic break even number of units for this operation? (Assume a $30 price and ignore interest costs associated with the timing of the lease payments.)

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Solution Preview

A. What is the accounting cost function for this business (ignoring parts)?

For accounting purposes, we consider explicit costs only.
Fixed Costs=Lease cost of van+ insurance costs=$5000+$2500=$7500
Variable Costs=$5 per service call
Ignore parts costs
Total Cost=Fixed Cost+ Total Variable Cost
TC=7500+5Q
Where Q is number of service calls

B. What is the ...

Solution Summary

Solution determines the accounting and economic cost functions in the given case. It also calculates economic break even units.

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