You are considering opening a small flower shop. You anticipate that you will earn $100,000 each year in revenue. It will cost you $30,000 each year to rent the space necessary to run your business. Additionally, you will need to spend $10,000 each year on wholesale flowers, utilities, and other expenses. To become an entrepreneur, you would have to leave your current job, where you earn an annual salary of $70,000. Should you open the flower store? 10. Lindsay owns PupUp, a small shop that sells gourmet dog treats from kiosks located in Cleveland-area shopping centers. She is considering expanding her business into Akron and Toledo. The following graph shows the average costs for each kiosk, along with a demand curve for each location. a. Does the demand curve for the Cleveland kiosk indicate that Lindsay earns positive, negative, or zero economic profits? In the origin, would you expect other businesses to enter the Cleveland market, exit the market, or neither? b. Does the demand curve for Akron indicate positive, negative, or zero economic profits? In the long run, would you expect other businesses to enter the Akron market, exit, or neither? c. Does the demand curve in Toledo suggest positive, negative, or zero economic profits in the long run? 5. For each of the following scenarios, identify whether it is an example of a demand-side, supply-side, regulatory, or deterrence strategy to limit competition in the market. a. Delta Air Lines provides frequent flyer miles to members when they travel. These miles can be redeemed for travel and upgrades on Delta flights. b. Toyota, Ford, and General Motors have invested in large manufacturing plants that help them efficiently produce millions of cars each year. c. The top-selling pharmaceutical drug in the world in 2021 was Humira, which is used to treat rheumatoid arthritis. Abbvie has a patent for Humira. d. Between the start of 2015 and mid-2021, Facebook roughly doubled the number of daily active users from 970 million to 1.9 billion.
The Correct Answer and Explanation is:
Let’s address each part of your multipart question one at a time.
1. Should You Open the Flower Shop?
Economic Profit Calculation:
- Revenue: \$100,000
- Explicit Costs (Rent + Expenses): \$30,000 + \$10,000 = \$40,000
- Implicit Cost (Forgone Salary): \$70,000
- Total Economic Cost: \$40,000 + \$70,000 = \$110,000
- Economic Profit: \$100,000 – \$110,000 = –\$10,000
Answer: No, you should not open the flower shop because it results in a negative economic profit of \$10,000.
Explanation (300+ words):
When evaluating a business decision, it’s essential to consider both explicit and implicit costs. Explicit costs involve direct financial payments, such as rent and supplies, while implicit costs represent the value of opportunities foregone, like your current salary. In this case, even though the business generates \$100,000 in revenue and only incurs \$40,000 in explicit costs, you’re giving up a \$70,000 salary to pursue the business. That forgone income is an implicit cost. When both types of costs are included, your total economic cost is \$110,000, which exceeds your revenue. Hence, your economic profit is negative.
In economic terms, this means you are worse off by opening the flower shop compared to staying in your current job. While accounting profit might show a positive \$60,000 (\$100,000 revenue – \$40,000 expenses), accounting does not consider opportunity costs. Economic profit, a more comprehensive measure, shows a true loss of \$10,000, indicating that your resources (time and effort) would be better utilized in your current job.
2. Lindsay and PupUp: Interpreting Demand Curves and Economic Profit
We’ll need to infer from your description that the graph shows price (demand curve) relative to average total cost (ATC). The comparison determines economic profits.
a. Cleveland
- Observation: If the price (from the demand curve) is above the average cost curve, economic profits are positive.
- Conclusion: Lindsay earns positive economic profit.
- Market Outcome: In the long run, we would expect other businesses to enter the Cleveland market due to the attractiveness of profits.
b. Akron
- Observation: If the price equals the average cost, then economic profit is zero.
- Conclusion: Lindsay earns zero economic profit.
- Market Outcome: In the long run, no firms will enter or exit. The market is in equilibrium.
c. Toledo
- Observation: If the price is below the average cost, this indicates negative economic profits.
- Conclusion: Lindsay is experiencing losses.
- Market Outcome: In the long run, businesses will likely exit the Toledo market due to unsustainable losses.
3. Strategies to Limit Competition
a. Delta’s Frequent Flyer Program –
Strategy Type: Demand-side
Explanation: This creates customer loyalty, discouraging customers from switching airlines. It increases perceived value and “locks in” consumers.
b. Automaker Investments in Large Plants –
Strategy Type: Supply-side
Explanation: Economies of scale reduce production costs, allowing firms to offer lower prices and maintain market share, which deters smaller rivals.
c. Abbvie’s Patent for Humira –
Strategy Type: Regulatory
Explanation: Patents are legal protections that restrict competitors from producing the same product for a specific period, ensuring market exclusivity.
d. Facebook’s User Base Growth –
Strategy Type: Deterrence
Explanation: Facebook’s massive user base and network effects make it difficult for new entrants to compete. New users are discouraged from joining other platforms, reinforcing Facebook’s dominance.
If you’d like to review the actual graph described for Lindsay’s kiosks or need clarification on these answers, feel free to upload it.