Chapter 7: Problem 30

Small "Mom and Pop firms," like inner city grocery stores, sometimes exist even though they do not earn economic profits. How can you explain this?

Short Answer

Expert verified

Small "Mom and Pop" grocery stores may continue to exist despite not earning economic profits because they may have non-monetary benefits, like personal satisfaction and freedom in operating the business, and cover their explicit costs with accounting profit. Moreover, factors like strong customer loyalty, lack of alternative job opportunities for the owners, barriers to entry in the market, and the absence of large competitors may contribute to their continued operation. Owners may also find it sufficient to maintain their standard of living with just accounting profit, even if they don't earn economic profit.

Step by step solution

Define economic profit

Economic profit is the difference between total revenue and the total costs of a business, including both explicit costs (such as wages, utilities, and rent) and implicit costs (such as opportunity costs). When a firm earns zero economic profit, it means that the business is covering its total expenses, but not earning more than the opportunity costs of other alternatives.

Explain accounting profit

Accounting profit is the difference between total revenue and explicit costs only. It does not account for implicit costs, such as the opportunity cost of the owner's time and capital. A firm may have a positive accounting profit but still have a zero economic profit if the opportunity costs are equal to the accounting profit.

Consider non-monetary benefits

While a Mom and Pop grocery store may not earn economic profits, there could be non-monetary benefits associated with running the business, such as personal satisfaction, freedom to work in a preferred manner, and control over the business decisions. These non-monetary benefits could be enough to keep the owners satisfied and motivated to continue the firm operation.

Evaluate other factors

There could be other factors contributing to the continued operation of these small grocery stores, such as strong customer loyalty, the absence of large competitors in the area, or a lack of alternative job opportunities for the owners. Additionally, the owners might be able to maintain an adequate standard of living with just accounting profit, even if not earning economic profit.

Recognize the role of barriers to entry

Lastly, barriers to entry in the market could play a role in the sustained existence of these small grocery stores. Barriers to entry are obstacles that prevent new competitors from easily entering the market and capturing the market share. These barriers can include strict licensing requirements, high startup costs, or specialized knowledge. In conclusion, Mom and Pop grocery stores may continue to operate despite not earning economic profits due to factors such as non-monetary benefits, accounting profit, market barriers to entry, and other local factors. The decision to remain in operation is influenced by the business owners' satisfaction and assessment of their opportunity costs.