Solutions: Case Study – Beer or Cancer?
1. What is the opportunity cost of conducting cancer research? Break this into implicit and explicit costs.
We are given the information that the government provides $50,000/year for the department to conduct cancer research, and the costs of operating the research lab is $30,000. Philips offers $70,000/year to do beer research, but researching beer would increase costs by $5,000.
The best way to find our cost breakdown is to put this information into a table, where we can make a side by side comparison of the two options. In the cancer research column, we have a total revenue of $50,000 from government funding, minus explicit operating costs of $30,000. This leaves us with accounting profits of $20,000.
Likewise, in the beer research column, we have total revenue of $70,000 from Philips, minus $30,000 + $5,000, or $35,000 in explicit operating costs. This leaves us with accounting profits of $35,000.
Since we are looking at the opportunity costs of cancer research, we don’t have to worry yet about which option the department will choose. Since we know opportunity cost is explicit + implicit costs, all we need is the implicit cost of the next best option. In this case, when we conduct cancer research we forgo $35,000 of profits. This means:
Explicit Costs (lab operating costs): $30,000
Implicit Costs (forgone profits from Philips): $35,000
Opportunity Costs (Implicit + Explicit): $65,000
2. What option will the department choose? What are the opportunity costs of this choice?
Since we have already calculated the accounting profits and know that Cancer research gives $20,000 of profits, whereas beer provides $35,000, we know that the department will choose beer research.
Finding opportunity costs is the same process as before, except now our explicit costs are the operating costs of the beer lab, and our implicit costs are the forgone profits from cancer research.
Explicit Costs (lab operating costs): $35,000
Implicit Costs (forgone profits from Cancer research): $20,000
Opportunity Costs (Implicit + Explicit): $55,000
3. What is the total economic profits from this choice?
Economic profits are the difference between total revenue and all the costs of an action, implicit and explicit. With a total revenue of $70,000 from Philips, our economic profits are equal to $70,000 minus our previously calculated opportunity costs. Since $70,000 – $55,000 = $15,000, our economic profits from beer research are $15,000.
4. If the cancer lab was offered $30,000 to shut down what would be the opportunity cost?
If the department was offered $30,000 to shut down, this just creates another option. Remember that opportunity cost includes the implicit costs of the next best alternative. This means we must determine whether is is better for the lab to shut down, or to work with Philips.
We know that the accounting profits from a partnership with Philips are equal to $35,000. Since shutting down has no explicit costs, the account