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

Mom and Pop firms may continue to exist without earning economic profits due to a combination of factors such as low implicit costs, non-monetary benefits, access to resources, community support, and adaptability. The absence of high opportunity costs and the presence of non-monetary benefits can offset the lack of economic profit, while access to resources, community support, and adaptability help sustain the business operations.

Step by step solution

Economic Profit vs. Accounting Profit

Before we begin, let's clarify the difference between economic and accounting profits. Accounting profit is the total revenue minus the explicit costs (costs that involve direct monetary outlays). Economic profit, on the other hand, is the difference between the revenue and the sum of both explicit and implicit costs (costs that do not involve direct monetary outlays, such as opportunity costs). So, when we say that a Mom and Pop firm does not earn economic profits, we mean that their total revenue is equal to or less than the sum of explicit and implicit costs.

Factor 1: Low Implicit Costs

One possible explanation for the existence of Mom and Pop firms despite generating no economic profit is that these firms may have low implicit costs. This could be due to the fact that the owners are not sacrificing high potential incomes from alternative jobs. In other words, they may not have high opportunity costs to begin with.

Factor 2: Non-monetary Benefits

Mom and Pop firms may provide non-monetary benefits to the owners, such as personal satisfaction, independence, and a sense of purpose. These non-monetary benefits might offset the lack of economic profit and keep the owners motivated to continue operating the business.

Factor 3: Availability of Resources

The owners of Mom and Pop firms may have access to resources at lower costs than large companies, such as family-owned property or lowered rent in exchange for providing essential services to the community. Reduced costs can help these businesses continue their operations despite not making economic profits.

Factor 4: Community Support

Mom and Pop firms often play an essential role in providing goods and services to the local community. Some customers may prioritize supporting these businesses over larger corporations, providing a steady stream of customers who keep the business operating.

Factor 5: Adaptability

Smaller businesses can often adapt more quickly to changing market conditions than larger firms, which can allow them to survive despite not earning economic profits in the short term. They may be able to make quick decisions, adjust their offerings or prices, and tap into niche markets. In summary, several factors can explain why Mom and Pop firms continue to exist despite not earning economic profits, including low implicit costs, non-monetary benefits, access to resources, community support, and adaptability. These factors may make it worthwhile for the owners to continue operating their business.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Understanding Implicit Costs

In exploring why small businesses like 'Mom and Pop' stores remain operational even without economic profits, it's imperative to understand the concept of implicit costs. These are expenses that do not require an outlay of cash but still represent a cost to the business. For instance, the company's owner might have opted for a salary-paying job instead of running the store, which constitutes an opportunity cost and thus an implicit cost.

Implicit costs are often overlooked because they're not recorded in financial statements, unlike explicit costs which are clearly documented. This can lead both observers and sometimes the proprietors themselves to underestimate the full economic cost of running a business. However, acknowledging these costs is crucial when making informed decisions about a business's viability and when calculating economic profit, which subtracts both explicit and implicit costs from the total revenue.

The Value of Non-monetary Benefits

The concept of non-monetary benefits is vital in understanding the motivation behind small businesses. Non-monetary benefits encompass the intangible advantages that the business owners enjoy from their operations, such as personal fulfillment, community respect, lifestyle preferences, family tradition, and autonomy in their day-to-day activities. These benefits are crucial because, although they may not have a direct impact on the financial bottom line, they contribute significantly to the owners’ overall satisfaction and willingness to continue running the business.

For example, a 'Mom and Pop' store owner might derive a great sense of pride and accomplishment from serving their neighborhood, despite the lack of economic profit. These non-financial rewards can be just as compelling as monetary gains and are often a key reason why such businesses persist.

Community Support as a Business Pillar

Small businesses often thrive on community support, which can be a critical factor in their sustainability. This support extends beyond mere patronage; it includes the social and economic relationships that form between the business and the community members. Local customers might choose to shop at 'Mom and Pop' stores out of loyalty, recognition of personalized service, or a desire to maintain the unique character of the neighborhood.

This community-centric approach can result in a loyal customer base that values the presence of the business, in many cases even willing to forgo the convenience or pricing of larger retailers. Thus, community support is not just about the economic transactions but also encapsulates the shared values and trust built over time, reinforcing the business's role in the social fabric of the area.